VNThere are many reasons everyone should read and study "The Enzyme Factor" by Hiromi Shinya. The first is that he promises a cure for cancer and an extension of lifespan. The second is that it will dispel a hundred myths about what is good for your health. The third is that it will teach you about the digestive system, providing knowledge that will help you in all aspects of your life. The fourth is that the book is like that written by a seasoned and very successful chartist. Instead of examining 300,000 charts, he's examined 300,000 stomachs, and based on the outcome not of price moves, but on subsequent relapse into cancer or death, he's formed a theory of what causes disease and come up with a method of preventing it. The fifth is that the book has sold two million copies in Japan, and presumably will affect the world in many ways for the good.

Dr. Shinya is best known as the inventor of colonoscopic surgery. He maintains the largest endoscopic practice in the world, delivering, with his team of three other doctors, in his 45 years of practice more than 300,000 colonoscopies. He practices in Japan and on E. 55 St. in New York, and regularly treats US Presidents, English Prime Ministers, and Japan's Royals. I was one of the 300,000 he treated and I have never seen a more efficient operation from start to finish in any field. He shocked me a bit by giving me a diagnosis on two occasions without a biopsy, but as he said like many chartists I know "I've seen more than 300,000 of these so I know without any tests or numbers." His book makes the unusual claim that he's treated thousands of patients for cancer and never had a relapse. This is like the chartist who tells you he's never recommended a stock that has not gone in the direction he predicted. Presumably a patient he's treated who did have such a relapse would complain in one form or another if the statement weren't true, with the inevitable other consequences. And since the normal death rate from such diseases is 25% or more, the actual observed number is 20 standard errors or more below expectation, truly a lower probability than the spare parts in a junk yard assembling themselves magically and spontaneously into an ocean liner.

Dr. Shinya has a Galtonian personality in many respects. Like Galton, he never recommends a procedure or medication without trying it out on himself. He takes a dose of every medication he recommends for his patients, but had to stop when he took some Viagra-like substance as it almost killed him in recent years.

The book is replete with side facts that will change your life. He recommends that hospitals immediately start feeding surgical patients a full diet of solid food, not the bland mush and cereals usually given. He recommeds that babies give up bottles at one year old. He recommends all adults should refrain from ingesting any dairy products. He recommends that no water or any foods be eaten for 5 hours before going to bed. He has a patented method for making all dogs love him— rubbing saliva on his hand ( the same saliva so important because of its rich enzymes   for proper digestion), and then letting the dog eat it

The essence of Dr. Shinya's recommendations is that you eliminate all dairy and meat from your diet, and maintain a diet of 85% vegetables and fruits, and 15% protein from fish. He recommends the elimination of coffee, tea, snacks, alcohol, chocolate, and fats and oil, and advises adding sea vegetables to the brown rice, beans and root vegetables that are the staples of most vegetarian diets.

He advises an active sex life, moderate exercise, and above all much good water, which he recommends as Alkaline Kangan water.

Like most books of this nature written by a clinician and not a statistician, there are a myriad of untested theories and single factor causes of disease that are singled out without any testing or documentation. He believes that since he's examined more stomachs and intestines than anyone else that if he sees a problem there, and notes a diet that seems to correspond to it over time or between countries, or between healthy and unhealthy patients, that is enough for him to tell without examining "worthless studies where the numbers don't mean anything because the researchers can get them to say whatever they want." This is the same defect that I find with charting and almost all of technical analysis, although in this field the problem is deeper because the cycles change much quicker than they do, for example, in Japan where Dr. Shinya attributes the 25-fold increase in stomach cancer there to the inclusion of milk in school lunch programs starting in the post-war years.

The problem with such clinical observations is that you can't differentiate the valid science from the anecdotal which is not valid. You just don't know without further study which of his recommendations have any validity.

The essence of the theory behind his recommendations is that enzymes are the key to health.That there is a single source enzyme that controls all the others, and that this is used up by ingesting foods that have free radicals that use up good enzymes, and by eating improper foods that use up the good enzymes, which are contained mainly in fruits and vegetables.

The theory itself is unproven. There is no evidence that it prolongs life or prevents disease. And it is hard to differentiate its recommendations from many other theories that recommend similar diets.

Because of the importance of the subject to all, I have followed up all of Dr. Shinya's recommendations and examined all the scientific studies that might provide valid evidence concerning the merits of his recommendations.

This is a difficult field, because most of the studies compare two different groups at the same time, and then follow them up, or are retrospective in nature, looking at the characteristics of diseased persons versus healthy. Also, there is observer bias, the placebo effect, the problem of self interest, fantastic high cost of a proper longitudinal study, lack of double blind outcomes in most studies, and the lack of incentive to test anything but patentable drugs that can be used on a large proportion of the population.The problems are the same as in our field, where you don't expect a practicioner to set forth his recommendations, and then follow them up for 10 years before accepting them as valid. But in our field as soon as such recommendations are made, the form changes, making it even more difficult.

Nevertheless, some excellent longitudinal studies exist, including a 50,000 patient dietary study, a Harvard-Dana Farber study of diseased people, a Baltimore longitudinal study, and a nurses' study. Also, an Italian study of elderly patients, and various Scandinavian studies and Seventh Day Adventist studies exist. It would be too tedious for me to review each of these studies and comment on their merits and demerits and how they affect my estimate of the validity of Dr. Shinya's conclusions. However, there is near unanimity in all the studies that a diet without meat extends life span and reduces disease. Many of the studies are contradictory on the merits of dairy products and poultry but a good working hypothesis seems to be that fermented dairy products are healthy for you and unfermented products such as milk are unhealthful. I find no evidence that drinking tea or coffee is bad. However there is much evidence that drinking much liquid in your diet is very healthful, and Dr . Shinya's recommendations of eight 12 eight ounce glasses of water a day seems to fit in with beneficial effects in all the studies I have seen. As for the value of Fletcherizing food, coffee enemas, eating uncooked foods, and deep breathing, and the removal of all desserts from your diet, I find no evidence either way. I have shown all the studies that support or infirm his theories to him, but with a practice that involves administering 40 colonoscopies a day, as well as the thousands of diseased patients he claims to have treated over the years without a relapse, I was not surprised when he rejected my offer to elucidate all the statistics to him. He commented that he can understand them on his own but he doesn't believe in statistics anyway.

I have sent copies of his book to all in my family and believe that despite the many defects and gaps in his theories, that if one does not mind "giving up pleasure in eating but eating for health," as he recommended to me, that following the gist of his recommendations will do much to put you in a much better frame of mind for living and trading.

Ken Womack adds:

This is a fascinating topic and the book is one that I find intriguing. About a year ago I began a vegetarian diet but encountered difficulty transitioning my new diet into the household kitchen lexicon. What I found immediately was that I gained a moderate amount of weight as I inadvertently mixed in too many carbohydrates. Once that was under control I noticed that I was more alert, that I didn't become as drowsy after eating, and that pH began to shift to a more alkaline composition.

In the end the pressures of carnivorous life and the human weakness bested me. Vegetarian lifestyle is demanding, especially at first. However, I plan on giving it a go again - this time better prepared.

I think that there are ways to overcome the amino acid deficiencies of the diet. Fish-eating vegetarians are even better equipped to handle the nutrient battle.

The idea of portion control too has merit. There is most assuredly a battle taking place within us all. Unlike some markets, however, I think we affect the volatility rather than react to it. The lows are certainly consistent in their emotional impact, though.



 Predictably Irrational, by Ariely, (hat-tip to Riz Din for cite!) was a great read and has provided some deep insights into personal trading and many common everyday situations in the days after reading the book. It also provides a good basis for testable hypotheses of a quantitative nature in trading.

Behavioral economics is popular and most traders are familiar with Kahneman and Tversky's works. Some of the ideas were discussed in the Black Swan directly or indirectly. The idea is that people are not rational agents as posited by traditional economics, but rather are influenced by unexpected and rather random cues in their environment and lead them to make decisions which are not rational, and which the author asserts are predictable. We see this in other traders (but not us, of course) everyday. It is this element of predictability which he does not go into in detail and which give some ideas to the trader using quantitative methods to predict the path of prices and provide a laboratory of data. The author has documents many interest anecdotes with experiments conducted on subjects that seem to support his ideas. Presumably, but not documented, the underlying statistics of the experimental data lent support to his hypotheses.

Some of the random cues that influence people's decisions are:

  1. Relativity, where experiments show that choices tend to be made between relative values rather than absolute values. One example is where people tend to choose the middle of three choices, when on an absolute basis, the cheapest might have been the best value. We see this in the circumnocution of market prices. This effect is seen in dating where a girl with an ugly friend looks much better than she might standing alone. This might be seen in the comparison of two companies in the same sector.
  2. Anchoring is the tendency of agents to choose a price close to a price randomly presented to them earlier which has not rational connection with absolute value. Again we see this in market action with the tendency to revert to the opening prices.
  3. The issue of the illusion ownership which makes the agent tend to place an excessive premium on things he owns or is bidding on, even to his detriment. This makes it harder for people to get out of trades. This also might suck a trader in deeper than he wants to be having entered into an undesirable trade when it might just be better to wait.
  4. The ownership effect makes people tend to cling to trying to keep options open, even when its more advantageous to close the door and choose one alternative.

These effects occur every day in personal lives, and in the markets. The traders trick is to find those irrational behaviors that cause losses to other traders and exploit their predictability.

The observer effect might be seen in the market in the tendency of prices to revert to or near a prior observed price such as open or prior close.



A nice, clear definition: "a bear market is a 20 percent drop from an all-time high." We'll know when we've had one. Nigel Davies.

Like we used to ask, what about numbers on the table?

Using DJIA 1950-2008 monthly data (skipping the Depression because it can't happen again), a bear was defined as this month's close < 20% below the high of any of the prior 24 months. Comparing the mean return of months following bear months with all months in the series shows they are actually higher - though not significantly:

Note that at least some of the insignificance is stemming from the higher volatility of 'after bear market' months:

The higher volatility is quite statistically significant.

Speaking of numbers on the table, here's a reminder to budding real estate moguls just how pricey bubbles can get Homeowner offers her house and her 'love' for sale



Ayn RandFinally I could invest the time to start reading Atlas Shrugged. I have chosen the word invest advisedly here; I have finished reading Part I and decided to take a pause at the end of page 312.

Bearing fully in mind the introduction by Leonard Peikoff that begins by stating that Ayn Rand held that art is a “re-creation of reality according to an artist’s metaphysical value judgments”, it strikes me very hard to seek your opinion if really in the America of the last century there indeed were characters such as Jim Taggart, Orren Boyle and the sort of hoi polloi that has been described continuously in these 312 pages. I have no doubt that there were a lot of Dagny Taggarts, Hank Reardens, Ellis Wyatts who helped (re)build modern America further, but it beats me if really there was a time when the over-riding thought and action of the day was being shaped by Jim Taggart and Orren Boyle types as well. What do you think? Has the author erred in stretching the shadows far longer to produce the effect or was there really an America like that also?

Alex Castaldo attempts a reply:

You are not the first non-US reader of Ayn Rand to be puzzled by this question. As a foreign-born American I was surprised that her books were set in the US when you could easily come up with better examples of government/business connivance from other countries. Americans can consider themselves lucky that they are better off in this respect than some others. Indeed I have often asked myself where is the Italian Ayn Rand who would speak up about how some of Italy's wealthiest people have made their fortune largely through political connections and improper operations, and explain the difference between this and true entrepreneurship. Sadly he/she does not seem to exist (possibly for lack of readers).

Part of the answer may be that Ayn Rand was most familiar with Russia and the US, so of course she chose to write about these countries. Also, she was concerned about trends and developments rather than the immediate situation; the US in her books is perhaps the model of what could happen to any country if the disturbing developments she saw around her were to continue. Her books are, among other things, a plea for the US to retain (and improve) its traditional values and not adopt those of the then ruling class in Soviet Russia.



PitcherI wonder why tennis serves are not more similar to baseball pitchers'. I have tried to revamp my serve and am picking the left leg up high and following through with the right, the way all the right hand pitchers do, and it increased my speed and accuracy. Is there a flaw in this approach or analysis? I remember from squash the fastest serves I ever saw came from baseball pitchers.

Bill Humbert replies:

I remember Pat Cash reflecting that he felt he would have had a better serve landing on his left foot. Other great servers like Becker and Laver landed on the dominant (right) foot also. I switched from this style to the modern style while still in juniors — I found it easier to control, and easier to reposition myself at the baseline. But it would seem to suit a serve-volleyer to land on the dominant. Speaking of tennis, here is a little essay I wrote: Looking in The Mirror.

Players often go through long periods with their confidence low (I am in one now, both in my tennis and my investing). I believe that I am a good tennis player, capable of a certain standard of play, while my body is able ( which at the moment is not! ). I believe that with planning, practice, hard work I can get myself out of this rut, even though this is one of my worst. However that belief is not there when it comes to my trading and investing. Last year I blew up, losing too large a chunk of what I'd accumulated ( and spent ) over the years, and I've not traded since. I've gone back to work after having semi-retired, literally starting over. Not only that, I look in the mirror and ask whether those ten years of success and wealth accumulation were due to in large part luck - I'm starting to believe they were, and with that loss of belief there is no way I can apply the same principles I'm applying to the tennis court to get my mojo back. If you see a failure in the mirror, you will fail time after time. Here are some of the simple but expensive lessons I've learnt since watching Federer beat Nadal last year at Wimbledon.

1. Know your strengths and nurture them. We are all built with a particular strength, it's there to be nurtured. The right mentor might enlighten us, or sometimes even friendly opponents. Most improvement in a player's game comes from recognizing this strength and finding the opportunity to apply it over and over. Hide and protect your weaknesses, apply your strengths. You'll win more than you lose. Do you know yours?

2. Imitation leads to elimination. Much time is wasted by players trying to be what they are not, and giving away what they are best at in the process. Create your own style - that way you'll know its not been seen before.

3. Accept your shortcomings. Every player has holes in their game. A big step is made in accepting this. A player can then make better judgments on which balls to attack. This nurtures a more patient approach as the player realises he cannot hit every ball for a winner, cannot win every point.

4. Keep it simple. You do not have to be able to do know everything or do everything well to be successful. Success and winning is as much about getting the basic stuff right over and over again.

5. Know your next move. Rule 1 in grasscourt tennis: volley to the open court. With this rule in mind, you are applying an edge over and over without having to think about it. Your opponent may start anticipating, but he will be at a disadvantage more often than not. Having a set of moves from basic court positions simplifies your game. The task is then to execute. A good plan is very hard to beat even when they know what your are doing.

6. Don't play if you are injured. There nothing to gain. Injury means less practice, hesitancy during play, losses, and a spiral of falling confidence. Much like a depleted trading account which isn't letting you play as you would.

7. Do what it takes to restore your confidence. Any trick will do. Sports and trading are confidence games, and you are a useless player without it.

8. Know when it's time to hang up the racquets.

Steve Leslie writes:

I don’t follow tennis much any more but I have been researching some of the greatest players. As I suspected, on the men’s side Federer and Sampras are both 6′1″ according to Wikipedia. Becker is 6′4″. The women Lindsey Davenport and Venus Williams both go over 6′ and Sharapova is 6′2″. So compound their height and the high tech racquets that can withstand immense tightening of the strings and this in all likelihood are concomitant reasons why the serves are so fast today.

Basic physics dictates that to get greater velocity on the ball, the racquet head speed must be high. How you get there is up to you. Roscoe Tanner had a very compact swing as I recall. He was a striker. Becker would get there through a very long arc on his serve. He was more of a sweeper.

I do think that there is a corollary to the elbow problems that pitchers face and that is tennis elbow. Most likely due to the snap that the tennis player tries to get through the ball to obtain a little more velocity and the stress they put on the joint itself.

I know in golf that high clubhead speed is attained through shaft length, flexibility of shaft and acceleration through the strike zone. There is also a trampoline effect that is realized through the composite material used on the face and the design of the actual clubhead itself. In his day, Greg Norman was probably the greatest driver of the ball, which is a combination of accuracy and distance. He is considered a sweeper. Hank Kuehne and Daly are more strikers.

I still will never understand how or why Bryant played with a broken leg. Hacksaw Reynolds also allegedly played with a broken leg. A word of caution here. Bryant also had half his team quit at Texas A&M during his boot camp and according to the show on ESPN one almost died from heat exhaustion. Kerry Wood may have been permanently ruined because of abuse and pitching hurt and before he was sufficiently healed. And my all time hero, Dave Dravecky pitched after receiving treatment for bone cancer and broke his arm forcing amputation of his arm. These are two stark examples. I could also mention Mike Ditka, Joe Namath, Dick Butkus Dan Marino who walk like 80 year old men. There is a big difference in playing with pain and playing when really physically damaged.



Woody'sI really don't know why I go to Woody's BBQ [menu pdf] so much. Perhaps the convenient location, consistent food, and great sweet tea have something to do with it. Maybe it's just that I happen to drive by their location most Saturdays when I'm hungry, or have some Pavolvian response that I'm unaware of. Whatever it is, Woody's is my default BBQ place here in town, when I don't feel like driving over to Arcadia . Woody's is a chain of BBQ places in Florida that serves good, but not great BBQ. Their portions are ample, the meat is tender, and the prices are rock bottom. Their sauce, which comes in three varieties, is really delicious. Woody's likes to baste their meat and chicken wet, and then smoke it while continuously basting with sauce. I usually go there for their sliced pork sandwich, which is a huge pile of thin sliced pork, served on a large toasted garlic bun. There's a good 10 oz of pork on the sandwich, and plenty of sauce at the table in which to dress it up according to tas te. The sandwich is quite tasty, and is a meal in itself. My experience with their BBQ ribs has been uneven, sometimes great, usually OK. Whenever I go there, I avoid the fries, which tend towards being soggy, and dive right into the BBQ beans. Simply put, Woody's BBQ beans are world class, with plenty of bits of crispy salt pork in each serving. Their beans are well cooked, with just the right amount of BBQ sauce added, without overpowering the flavor of the beans. Woody's also serves a creamy cole slaw that's delicious if one adds some pepper and Louisiana hot sauce to it at the table and mix it in. One thing I never fail to eat when I'm there is the deep fried garlic mushrooms. The batter they use is sort of a tempera batter, and the mushrooms are first rate in quality. The contrast of the crisp batter with the perfectly cooked mushrooms creates a perfect balance, and satisfies my taste buds. I've tried other things on the menu such as their fried catfish and chicken fried steak, and found them to be good, but not memorable. Woody's decor can be best described as faux Western kitsch. Although the decor isn't very inviting, the place is always very crowded, with a 10 minute wait being the norm. Woody's isn't world class BBQ and makes no pretensions as to being the best. They are good, not great, but are a must stop if one happens to be driving by one of their locations and is hungry. Woody's purpose in the world is to serve ample portions of hearty BBQ to the working man, and for that, the world is a little better place.



Someone I met recently told me that in about seven years time each and every atom is replaced in our bodies. Then how come the much analyzed chemical reactions of the body and brain retain memories and learning acquired across years? Irrespective of the proverbial seven year itch arising in the 7th, 6th or 8th is it then about revisiting the premises left now only in memories upon which the original pleasance of the relationship rests still upon?

Like in a computer where one keeps on upgrading each and every component and on average ending up replacing every part in about seven years when nothing existing today was in the original computer the data, the feel of the desktop remain the same and we still call it the same computer. Is life and the kind of computing the human brain does more similar to network computing? What else might a social process be similar to from the world of computing? Can principles of computer networking be applied to find valid applications in a social process called the stock market?

Is life using more of google spreadsheets kind of structures than using the locally resident ex*el type utilities? How come across generations within family trees certain patterns of thought, action and being are ingrained? What then is the reason for a flapping of a butterfly's wings in one nook of the Earth bringing about a typhoon in another corner of this planet if life being a seamless network of information and matter is really incidental to its carriage?

Would a market be over N years not replacing each and everything that existed before that period and still be the same market? DJIA has just one original stock for an example. It is still the same market. It is the same stories and folklores. What is the value of that N for each different security, each different market sector etc. etc. Will the differences in N reveal any differences about the markets, assuming measurement of such an N will be feasible somehow?

Is reality, in the markets and otherwise, just a continuum of information while matter keeps getting replaced, regurgitated, re-structured, re-invented etc. etc.? Why does then someone as successful as the Sage proffer wisdom that one ought to own companies that do the same routine thing that we would require all our lives? The coke is the same as it was twenty years ago? It perhaps is getting different again at its own pace. In the same vein then why is there only one company such as 3M yet that persists on achieving not less than 60% of its sales from products that did not exist three years ago?

May be a good point to begin on this trail is to first imagine and find which variable(s) from the characteristics of securities or companies can be those that which change completely in N years across a set of securities, value of N being then the next variable to study?



Google strikes again. With its huge computing power it is changing the way science is done, according to The End of Theory: The Data Deluge Makes the Scientific Method Obsolete, an article by Chris Anderson in Wired magazine.

Some excerpts:

"All models are wrong, but some are useful." So proclaimed statistician George Box 30 years ago. […] Speaking at the O'Reilly Emerging Technology Conference this past March, Peter Norvig, Google's research director, offered an update to George Box's maxim: "All models are wrong, and increasingly you can succeed without them."


Scientists are trained to recognize that correlation is not causation, that no conclusions should be drawn simply on the basis of correlation between X and Y (it could just be a coincidence). Instead, you must understand the underlying mechanisms that connect the two. Once you have a model, you can connect the data sets with confidence. Data without a model is just noise. But faced with massive data, this approach to science — hypothesize, model, test — is becoming obsolete.


There is now a better way. Petabytes allow us to say: "Correlation is enough." We can stop looking for models. We can analyze the data without hypotheses about what it might show. We can throw the numbers into the biggest computing clusters the world has ever seen and let statistical algorithms find patterns where science cannot.

Dylan Distasio replies:

I didn't see any compelling argument in that article that the scientific method is on the verge of becoming obsolete.

While cloud computing can be a great tool for analyzing protein folding or looking for extraterrestrial signals, I don't see how throwing "the numbers into the biggest computing clusters the world has ever seen and let statistical algorithms find patterns where science cannot" is a viable approach.

This sounds like the ultimate in overfitting data (although I guess there is no model!). Venter may have come up with a brilliant software tool for rapidly sequencing DNA, but it's only useful within the context of a genomic model that was built using the scientific method.

I still see noise without a framework to hang the data on, and a testable (i.e., potentially refutable) hypothesis. 

William Smith relates his experiences:

StatsI work with large amounts of data all the time. Failure to understand the mechanism and specify the model form based on the mechanism leads one to make worthless models that fail miserably.

The noise level is very high in these types of datasets. Many "patterns" are just random but algorithms will treat them as real. The "kitchen sink" approach of throwing many algorithms on a cluster of processors at a large set of data is guaranteed to find something. If all that's there is noise, they fit the noise. When tested on new data it had never been exposed to before, the model won't work. I have seen even the most sophisticated machine learning algorithms fail, support vector machines, for example.

I have worked with many modelers who have tried the automated brute force approach and they have never once managed to solve the problem they were working on.

I have built models in the field of chemometrics that I patented which use only two variables because I understood the mechanism. It was an iterative process, and I certainly didn't get it all correct in the first cycle. In fact, I have had some outstandingly stupid ideas. But the process of testing, refining, discarding, and generating ideas is hypothesis driven science, and that is a process which hypster computer scientists cannot perform. Never seen one of those guys capable of doing it in the last 15 years. If this is where Google is going, they are in deep kimchee and wasting a lot of money. Looking for patterns in the hay does not find the needle.



The latest piece by market commentator James Montier looks at confirmatory bias. In the report, Montier discusses how confirmation bias pops up everywhere, giving examples from job interviews, the field of medicine, and criminal investigations. He provides a nice quote on the topic:

The human understanding when it has once adopted an opinion (either as being the received opinion or as being agreeable to itself) draws all things else to support and agree with it. And though there be a greater number and weight of instances to be found on the other side, yet these it either neglects and despises, or else by some distinction sets aside and rejects; in order that by this great and pernicious predetermination the authority of its former conclusions may remain inviolate.. . . And such is the way of all superstitions, whether in astrology, dreams, omens, divine judgments, or the like; wherein men, having a delight in such vanities, mark the events where they are fulfilled, but where they fail, although this happened much oftener, neglect and pass them by. — Francis Bacon (1620)

And there I was, thinking it was a relatively new insight to the human condition (I'm currently reading The Black Swan which deals with these themes and others).

Montier concludes with advice on how to fight confirmation bias:

The most obvious way of avoiding plunging headlong into confirmatory bias is, of course, to look for the disconfirming evidence. When you meet companies seek to ask them the complete opposite of what you actually believe. Root out all the information that would show you that you are wrong. So if you expect margins to continue to grow, say, then spend your time probing for evidence that margins are under pressure.

This is easy to say, but actually hard to practice. It doesn't come naturally to us at all. For instance, when I read a bearish piece of research I often find myself nodding in agreement. However, when I read bullish research I find myself, tutting and circling all the points I disagree with, often ending up with large amounts of ink across the page before I throw the note away, dismissing it as typical of the bullish junk produced by our industry. I'm not an unbiased evaluator of evidence (and the chances are that you aren't either).

You should also pay attention to the absence of evidence as well as its presence. This is reminiscent of the Sherlock Holmes story in which the vital clue was that the dog did not bark in the night. One's attention tends to focus on what is reported rather than what is not reported. It requires a conscious effort to think about what is missing but should be present if a given hypothesis were true.

I fear my life is an exercise in confirmation bias!

Russell Sears comments:

Well I would agree that it is hard to do, but I would say Mr. Montier is still asking the wrong question.  With the markets it's not all about you. It is not about what you think you know, it's about everybody and what everybody else is thinking. So the right question is to ask the company to prove what everybody else is saying about it. After all if you don't think that the consensus opinion could be wrong you should be in the index. But the hard part of the investment game is asking the right question, the one where the consensus is wrong. You could start by considering where are consensus opinions consistently wrong, and which companies are good at deception?   



One should interpret all this negative news as nothing more than the foundation for the Fed to do something very bullish for stocks.

George Humbert replies skeptically:

  1. During the BSC take-down, DC actors wished to inflict the maximum pain on equity holders. Is their bloodlust sated?
  2. It is an open question whether or not a given flow of rate moves and rhetoric can/will drive US equities. The Bearded One, foolishly, tried to talk up the dollar, and failed. He did succeed in wrong-footing the forward rate curve, triggering unknown billions in losses around the world. Is it likely he'd get stocks right?
  3. Are rallying equities in the Fed's interest? The one area where Bernanke has really excelled is in extolling socialist nostrums, providing rhetorical cover for State expansion, and specifically growing the Fed's book of administrative powers. Would not a Black Monday 1987 redux strengthen the case for more and more Fed control over capital markets?
  4. No doubt, looking back in time, the best equity returns followed doomsdayish dramas such as those we've seen in the past few days. I merely wish to note that the interests of actors inside the Beltway may be in a cycle more exceptionally inimical to capital than those seen in prior episodes.

Victor Niederhoffer notes:

Two other bearish memes before the Fed meeting: the Case/Shiller index and consumer confidence will be announced today (6/24). The latter is 100% correlated with S&P last month and the former is even more consistently bearish than the weekly financial columnist. But is this good or bad before the Fed meeting?



HumilityI've been writing a book for the past couple of months and thought everything was smooth sailing. I've finished seven chapters, and thought I had pretty good content/style. One of my old publisher friends, who's an editor, requested a copy of what I had already written, and I sent him a file of the first seven chapters. He did a excellent critique of my work, so far, and made numerous suggestions that filled three pages. Re-reading his suggestions, at second glance, I realized that his comments were pretty brutal, but dead on. Following his suggestions, I'm going to undertake a massive re-write, polish it up, then submit it back to him for his comments. This back and forth made me realize that publishing is a market in itself, with the in's and out's that are similar to any market that I trade in (however, I'm in the dark as to the in's and out's). My lack of knowledge in the writing/publishing market allowed me to make over 40 newbie mistakes, all of which can be easily modified and corrected. I will keep on plodding ahead with this book, and still plan on having it completed by the fall. My initial foray into writing the first book makes me realize that I'm the unexperienced guy in this market, and would be fad-able if writing/publishing were a trading market. I have developed a plan to gain the necessary skills to write a quality product that will make me proud to display my name on the cover.

The lesson my writing experience has taught me is that just because I've done all right in certain markets trading wheat, grain spreads, scalp, and have a certain wisdom acquired from years in the pit, it does not translate to many other markets where I'm a complete tyro. As I don't have the experience, knowledge, contacts, or superb writing skills, I'm at a distinct disadvantage when it comes to trying to make a winning trade in the writing/publishing market. As many of you have published excellent books (I own many books from authors on this web site), I wonder if you authors have had to overcome the same obstacles that I'm trying to surmount. Sometimes, this book project makes me feel like I'm one of the guys who used to have $10K in his account and leased a seat to trade wheat, hoping to strike it rich. None of them ended up making money and all ended up in some other field. Although I already have my field, I have a steadfast resolve to make this book work, and give enjoyment to my readers.

One lesson I've learned through this experience is humility, and my complete ignorance of other markets. Since I don't give up on projects, once started, you can still expect my book sometime in the fall. I'm going to self-publish it, at first, then see what happens. My thanks to Vic, Laurel and other readers who have given me direction, support, and guidance in this project.



K ZWhen excited properly gases emit radiation at specific wavelengths, because electron transitions to lower energy levels is quantized. This is seen well as emission lines on spectra.

If stock prices were attracted to round numbers, in terms of frequency one might expect to see something like a spectral pattern. For example, the count of daily closing prices in SP500 should be higher around round numbers. A dot-plot (like a histogram with dots) was used to check for round-clustering using daily SPY closes multipled by 10 (to replicate the actual SP500 index number). This particular dot plot tallies up to 7 observations per dot, and each column represents a bin of 20 SP500 points (eg, "1000" is all daily closes from  990 to 1010)

A dot plot of 10X SPY does not appear to show clustering around the "hundreds" (900, 1000, etc) in S&P 500.



`Now! Now!' cried the Queen. `Faster! Faster!' And they went so fast that at last they seemed to skim through the air, hardly touching the ground with their feet, till suddenly, just as Alice was getting quite exhausted, they stopped, and she found herself sitting on the ground, breathless and giddy. The Queen propped her up against a tree, and said kindly, `You may rest a little now.' Alice looked round her in great surprise. `Why, I do believe we've been under this tree the whole time! Everything's just as it was!' `Of course it is,' said the Queen, `what would you have it?' `Well, in our country,' said Alice, still panting a little, `you'd generally get to somewhere else — if you ran very fast for a long time, as we've been doing.' `A slow sort of country!' said the Queen. `Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!'

From Lewis Carroll's Through the Looking Glass



I recently watched a documentary telling of a future where genetic breakthroughs lead to the end of major cancers, leading to significant life extension (in full here ); I read an article about futurist Ray Kurzweil, and life extension in the New York times ; I saw a trailer for a new film of The Curious Case of Benjamin Button, in which the main character ages in reverse; and I learned of a discovery, where scientists have effectively reversed muscle-aging in mice. It all throws up questions about ethics, Frankenstein creations, etc, but personally, I can't wait. For sure, living more healthily into older age requires new thinking about consumption and savings patterns and the relationship between demographics and equity returns. And then there is the wondrous benefit of compounding your savings over those extra years. It almost makes me wish I cared more for money than I do!



During the past week the public has been hit by bad news about the economy and the geopolitical situation. I could not find a single positive event in the news. Even potentially good things have been presented from the negative side. Some examples: 1) The Saudis announced an increase in oil production; 2) US considers starting to exploit their resources more fully (apart from environmental considerations); 3) China increased the price of gasoline. Eventually they were presented as bad news: 1) The Saudis have declared this many times and moreover we really do not know how much oil they have left in their reserves. 2) Oil from Alaska could contribute very little to reduce US import dependence. I even heard that 3) in China this measure could increase demand; and in any case Chinese consumer behavior takes a long time to adapt to new situations. On the other hand other, potentially more negative,  news had an impact on oil prices. Israelis a month ago exercised to bomb Iran facilities. The problems in Nigeria could disrupt extraction. Alternative energies are still a long way ahead. Then we are hit by news about the credit crisis, mortgages, frauds, a plunging housing market, growing deficits.  Skyrocketing inflation is putting at risk emerging markets growth. Food prices and climate change are going to bring instability and famine in many areas of the world. The free trade era may be nearing an end amid food and growth concerns.

The stock market is going to retest last January lows. Earnings forecasts are negative. Recession is behind the corner. Consumer sentiment is at its lows. Terrorism is a threat and the situation in Afghanistan can only get worse and at best it will take a decade to be solved. Similar comments for the operations in Iraq. I find all this quite discomforting. In this climate, it is impossible for the public to build their own map of opportunities and risks if news is so unbalanced to the negative side.

Sometimes I really wonder if it is possible for someone or a group of people/interests to design and implement these information campaigns. Military info ops are nothing compared to what we see on TV and read on newspaper and the internet these days!

I have seen more than one recession in my life. It is always the same pattern.

On the other hand, I remember during the dot.com bubble, every company announcement was the demonstration that a new era had begun. Every bad news was interpreted as uninfluential in the powerful flow of innovation and creativity of the internet revolution. Of course it was not like this.

Now we confront our decision making process with the oil bubble, the weak dollar, the unsold inventory of houses, inflation and so on. I do not want to be positive at all costs. The long process of growth started after WWII brought improvements in many parts of the world. I understand that new elements could arise at a certain point to undermine what for us is now given for granted: a continuous seamless improvement of our conditions. But I really do not think this is the case now.

Between the lines we need to able and read the key drivers for continued growth and development in the next years. "They" are simply making it difficult for the public to see them and make sound investment decisions.

Vince Fulco reviews the events of Friday:

The bears could not have scripted a better one for quad witching if they had hired Hollywood writers for the purpose.  It all revolved around six negative words in the headlines, though the reality was more nuanced:

1) DOWNGRADE- of the monolines the prior night which has been discussed ad nauseam by fixed income and equity analysts alike for months (whoops 5 notches). What happened to efficient markets and discounting of information?

2) WAR- Israeli war games over 3 weeks old, in plain view of most neighboring countries. Comes on the heels two weeks ago of politically motivated utterances by a minister re: war's inevitability which caused selloff and recovery in numerous instruments.

3) PRE-RELEASE- Newswire "reports" unsubstantiated rumours that Mother MER will pre-release. This is after days of repeated number trims and caution by early/late street analysts to the bulge brackets' plight.

4) CREDIT WATCH NEGATIVE- Rating agencies NOW waking up to the reality of >$4 gas and fleets that are inefficient and unsound. Not to mention finance arms run amuck.

5) QUAD WITCH- Primary TV program reporting OT1H "look out for increased vol today" and OTOH "the day isn't as important as years past due to traders spacing out their portfolio changes".

6) OFFERINGS- After weeks of endless capital raises among the big boys, the regionals start to hit the accelerator shortly after being "outed" or "goaded" by GS and (in repeated attempts) by Fed and Treasury.

Tailor made IMHO and a sight to behold given SPUs were only down 4-5 points at 5:00 am. Although it involved numerous random events, sure has a deus ex machina feel to it.

James Lackey writes:

1. Keep in mind it is an election year. 91 saw similar doom and gloom. After the fact Clinton inherited a booming economy and could raise taxes.

2. Dem Sweet is a lock. Taxes are going up without a vote. Best way to have taxes lowered on the rich would be a wicked recession.

3. Global warming green meme is a rise in taxes, a whole new regime of taxes and carbon credits. The quick way around this is to Jam up all energy prices as high as they can get them. No politician can raise energy taxes when even electricity bills go limit up.

The counter argument is now being formed. At the barber shop this am Newsweek or one of the rags had "Global warming is a Hoax". Yet on Fox News on the TV next to the news rack they had Dow at 3 month lows, Energy at highs, stagflation. Ill be looking for a new barber shop without the TV.



This story just hit Bloomberg news service ("Spanish Treasury to Exclude Italian Government Bonds"). If true, it represents a real threat to the long term sustainability to the European monetary project. The credit crisis, strong euro and slowing economies are finally starting to test the patience of European policy makers. Since the inception of the Euro back in 1999, European Central Banks never distinguished between the credit quality of the various European Sovereigns. That meant that Italy for example could raise funds via debt issues at terms close to those of Germany even though Italy's financial house is in very different order from that of Germany. It was a classic misallocation of credit risk. That's all set to change and Italy's funding costs could skyrocket. Belgium, Portugal and Greece and potentially all in the same pickle. The immediate trade that comes to mind is to short Italian debt versus German or shorting the Euro, which is perhaps the most overextended against the Yen.

John Floyd adds:

All that makes sense. Italy has lost roughly 30+% of competitiveness over the past few years and has also, wisely, extended their debt maturity, not to mention their other weak macro fundamentals. The extended debt maturity would also, should they choose to do so, make it advantageous for them to leave the Euro. The sovereign spreads are all still priced fairly tight with 50 bps of each other for 5-10 year maturity. Compared to where Italy, etc. were during the EMU crisis at many hundreds of bps. I would consider higher grade corporate to be long against short the weaker sovereigns, this also has positive carry.



We have a two year low for the German Bund contract, the second or perhaps biggest futures contract in the world by volume (notional value). What could have changed to make the prospects so bad relative to the past over the next ten year horizon? I note this from a speculative context and seek qualitative insight.

Eastsider replies:

1) There had been a macromeme along the lines of: Europe is behind the US in this economic cycle, and the ECB will have to cut rates soon… Trichet's hawkish talk a couple of weeks ago triggered a stampede unwind of that trade rationale.

2) Reports of massive derivative/structured note plays on the Bund curve likely getting tripped too.

J. Rollert adds:

Inflation is high with a strong currency, yet if it regresses back to mean modestly the inflationary pressures will increase.

Double whammy… to bunds. Also foretells major political battle.

Edward Talisse writes in:

I traded bunds for many years whilst working for the blue shoes in London. ECB chatter is obviously hurting sentiment there but something more interesting is also afoot. The bund curve is close to inverting between 10y and 30y. This is a highly unusual situation in Germany where the curve generally remains steep though various cycles. The rub is the structured product market in Europe, which is absolutely huge. Most interest rate derivative notes are written on the back of a CMS (constant maturity swap) structure. The holders of the notes basically sell volatility to earn above market coupons. The problem is that as the curve flattens, CMS gets absolutely killed. So there is a big demand in Europe right now to get into long dated flattening trades. That means people buy 30y and sell 10y, thus depressing the bund future price. 



There seems to be something odd going on with German real estate. People are clamoring for 'energy efficient' apartment/office blocks that are near the city centre, whereas many older buildings in the outskirts have a low rate of occupancy. (From a British friend visiting Germany).

The clamor for "green" property in Germany is driven by social pressures, not economic pressures, even though they have been much, much better at energy efficiency than the rest of the Western world for decades.

Immediately after WW2 the Germans started doing serious, formal research into how to make existing or new buildings energy efficient, while most of the rest of the world was mostly not thinking much about it. About 15 years ago some of them realized that a graph of the increased construction cost to make a building more energy efficient vs. the payback is not a straight line - it has many bumps in it. One major bump occurs where the building is energy efficient enough to not need a heating system. Spending slightly less on efficiency means buying a boiler, heaters, piping, etc, and spending slightly more means greatly diminished return on investment. Ironically, in researching these ideas they came primarily to the US, where we've built 2 or 3 such houses per decade for years. The Germans wrote a standard for how to do this, and as of 10 years ago they had built 6 such buildings, all single family residences. Now they have well over 10,000 built new and renovated, not only houses but sports facilities, office buildings, schools, apartment buildings, etc., often for lower cost than normal buildings, because of the decrease in construction cost associated with skipping the heating system.

Perhaps their culture has something to do with it, and with our attitude too, as our parents' generation came to literally rule the world by controlling access to oil in WW2 (the fighting in Burma was not about palm trees, ditto for Romania, the SouthWestern USSR soviet oil fields, etc.) The Japanese sent the world's largest battleships out to fight without enough fuel for a return trip, and when the Germans made the world's first jet fighter planes they were rumored to be towing them to the runway with horses to save fuel, but that was not true. The army had all the horses, the air force used cows. Now Germany and Japan are the most energy efficient countries in their hemispheres, while Russia and China and the US, who won the war, are the least fuel efficient.

In the US we've been responding by clamoring for "green" buildings which in fact use more energy than comprable buildings (on average), but with almost nobody asking to see utility bills and almost nobody showing bills, worse and worse buildings become more and more popular. Ditto in Germany, as the image of environmental friendliness sells much better than actual environmental friendliness in the form of energy efficiency or any other form.

Certainly an example of the lack of counting having a huge effect, and the public paying more than they deserve to pay to end up with something that has less real value than simply buying nothing.



DVGAssociated Press (AP) is a cooperative owned by the major newspapers. Its purpose and history have been to preserve the monopoly power of its entrenched owners against newcomers, both new newspapers and others.

Where permitted (most prominently in the agricultural field, for example Ocean Spray Cranberry growers or Blue Diamond Almond growers from whom Victor and I used to buy for our American Almond company), cooperatives are a government-sanctioned cartel allowed to limit production and fix prices.

I was amused recently when my niece, a star at business school, proudly announced to the family she was taking a summer job at AP because it was a "non-profit". When I explained that it was only non-profit in the sense of Ocean Spray Cranberries, designed to maximize the profits of its owning commercial companies, she became quite annoyed.

This "I only want to work for a non-profit" preference of young people is very common these days. Whenever I try to explain that working for a non-profit tends to be less socially useful than working for a "profit", I get nowhere. (My point being that a "profit" has to be socially useful or it would not exist, and ditto for the job they are paying you for. While there is no such feedback or test for a "non-profit" company and job.)

I'd be interested if someone could better explain it, or point to a source that better explains it.



Jim SogiWe had a dinner on the boat tonight at sea, drifting with the wind and current. I positioned the boat so it would generally drift back towards the harbor, but as we drifted I thought how similar it felt to have a position with the intent of holding. The position drifts, sways, goes up and down with the winds, currents and waves without any action. This quite a contrast to the deliberate positioning and surfing the waves in the ocean and the market which takes concentration and accuracy. The boat drifted sideways. We sat and enjoyed a nice dinner at sunset with no one else around. The ocean is a different place. No one owns it. No one can stake out an area. Its all fluid and in motion.



John Tierney, in another great article in Science Times. "The Future is Now? Pretty Soon, at Least", includes energy predictions from scientist Ray Kurzweil, "Solar power may look terribly uneconomical at the moment, but with the exponential progress being made in nanoengineering, Dr. Kurzweil calculates that it'll be cost-competitive with fossil fuels in just five years, and that within 20 years all our energy will come from clean sources."

We have heard similar predictions before, but now oil over $100 a barrel is deploying billions of smart investment dollars into both alternative energy and new oil exploration and drilling. Billions of dumb investment dollars are flowing too, with government subsidies and tax credits pushing wind power, ethanol, and other projects that distort markets and wasting scarce resources.

Solar and hydro power are another matter. Some solar installations spend millions to physically move solar panels to follow the sun across the sky. But new solar membranes will grab all solar radiation from all angles and wavelengths, transforming them to electricity. The race along dozens of separate solar technology pathways will decentralize and localize solar power. Just as computing innovations brought low-cost, high-power computers into the home (and five into my home), low-cost, high-efficiency solar technologies will feed better, cleaner power into home electronics and soon, into plug-in hybrids and all-electric cars.

Just five years? Well, five years for solar energy to be cost competitive. Another five to ten for wide distribution of local and home-based solar technologies and significant percentages of plug-in cars. I live in Seattle, and if the climate here keeps cooling, solar for us will be further in the future. (It snowed here last week!)

Bloomberg reports yet another large oil discovery in Brazil. With the Saudi's agreement to increase output, new output due soon from Iraq, and increases from many other sources, the question is whether deep and expensive oil from Brazil will come on-stream in time to sell at high prices. The answer may be yes, since expensive and sophisticated solar, hydro, and nuclear installations that will be widespread in the U.S., Japan, and Western Europe may stay out-of-reach for most of China, India, and Latin America.

But once the billions of dollars have been spent on deep sea drilling and build-out of infrastructure, well, these sunk costs will be twice sunk. Just as billions spent to build homes now empty, or billions spent earlier on fiber-optic cables long dark, this boom-time infrastructure can serve future consumers, if not current investors.

My short-term prediction is half-price oil within six months. I figure the current President or the next is likely to release Strategic Oil Reserves after announcing we have an extra supply, thanks to major foreign policy successes. The current President can claim stability in Iraq makes the world safer and less in need or extra-large U.S. oil reserves. The next President can claim that vast reserves of high-quality oil available free to the military would encourages foreign adventures. Plus pundits can claim the reserve was a plot by a President too-friendly with oil companies, to help his oil buddies. Whatever cover is offered, releasing a hundred million barrels would push prices down and make politicians popular. The strategy may be to wait until new drilling is approved in the U.S. and off-shore, before releasing reserves that in a few years, with higher domestic supplies, will seem as necessary.

As for hydro power, the key insight is that water is a lot heavier than air, and flows downhill all the time while wind blows only some of the time. Unfortunately, private property rights don't exist for U.S. rivers and streams. State and Federal government claim authority to mismanage these resources, so private firms are both unable to restore salmon runs and habitats, and unable to generate safe and clean power from fish-friendly, in-stream turbines.

HydroVolts, a "Micro-Hydropower" company, offers "Hydrokinetic Turbines" for generating energy from modest stream and irrigation flows (the only flows sometimes privately managed). The turbines float from anchors and generate power from river or tidal flows. A proposed 16 MW tidal power project for Tacoma Narrows was not approved, but the technology works well for smaller rivers and streams. Right now though, lack of property rights frustrate most efforts to deploy this technology.

At least with solar power, government are less able to regulate or block the sun (much to the the dismay of candle makers both in France and the U.S.).



Here's from today's (May's) producer price report:





Greg Van Kipnis replies:

Understanding the "pig" in the python phenomenon, as Eastsider refers to it, is instructive.

The point he is implicitly making is that as the lump in prices (the pig), stemming from energy and ag prices, works its way through each stage of value added in the US manufacturing/services production and distribution machine (the python), raw material prices diminish in importance.

Unit labor costs, offset by productivity gains, and profit margins become the dominant component of prices in the final consumption market. In our competitive markets, labor costs and profit margins are "compressible" and productivity gains are "irrepressible." Then there is the not so small matter of substitution effects to lower prices even more. As the cost of one ingredient rises, every businessman will press his suppliers to either lower their prices or find other substitutes for the other ingredients that were purchased earlier. In the end, consumer prices (and industrial prices) become "well contained."



T WTiger's accomplishments are truly remarkable. He is perhaps the closest illustration of professional perfection that we have witnessed in our lives. There are countless untold stories of achievement in many walks of life and of course, we can only admire and measure those we are familiar with. However its difficult for me to imagine such consistent and near perfect performance achieved under such highly visible pressure.Tiger frequently separates himself from the competition by his degree of mental toughness. I wonder how we can measure and learn that skill?

Like other readers of this web site, I try my best to be a role model for my four children. We are a tight knit family drilled in the arts of preparation, practice and discipline. Tiger Woods, Rafael Nadal and Roger Federer are the best illustrations of what an individual can achieve. There is no shortage of good role models.



The screaming about the demise of foreign faith in the US is matched in consistency only by the ongoing pouring of foreign capital into dollar assets:Eastsider



 I found myself lying awake in my bed last night thinking about the Nobel Prize Winner. No! Not like that….but about what he said in Stockholm last week. Expected Utility Optimization. What he said is that the goal of asset allocation should be optimizing the expected utility for the actual investor in question, and that the mean variance model should just be looked upon as a special case. And of course he is right. I mean, by the way he sets it up, he is right by definition. But….I am thinking how it would play out in the real world. In my fantasy, a consultant would sit down with an investor, asking questions to find out his preferences. Of course this is already happening in a general sense but here it would end in a very specific investor utility function). Then the asset allocation would be done based on the utility function.

I am thinking that what will be overlayed on the usual return/risk models, are constraints (e.g cutting off tail risk, smoothing out fluctuations and what have you) and while the model presumably maximises return given a risk level and those added constraints; if we add constraints there must be risk premia transferred to someone else? By definition, since the investor specified his utility function (and given that the formulas and models held up and he got "what he wanted") he is better off than before, but so must someone else be?

I am not sure this new allocation model will start a revolution in the way asset allocation is done. I think however that finding situations where other investors are up against constraints, could help open up possibilities and profits. In the micro realm, many traders prefer to cut off the risk of gaps against them, by not holding overnight. This might open up possibilities for traders well capitalised and with good stomach, to do just that (this must be tested). Other suggestions are welcome.

Adi Schnytzer critiques:

AdiIt never ceases to amaze me that people who know markets and work in them don't realise that we don't know the probability that anything will happen tomorrow unless we are in a fair casino. So the idea that anyone can maximize expected utility is nonesense since you don't know the probabilities. I am currently working on developing a risk index as a follow-up to such an index developed recently by Aumann. He cutely argues that even though we don't often know the probabilities to assign to events, it's important that, in principle at least, we have an index. Well, I've been looking for real life examples of his index (and my follow-up) in stock and derivative markets, and simply cannot find one. As a top bookie once said to me: "If I only knew the winning probabilities of the horses, I wouldn't need to know winners; I'd be making a fortune anyway." Spot on.

Jim Sogi adds:

Martin talked about "…cutting off tail risk".

The thesis that outliers shape the future is intriguing, but also that the risk cannot be eliminated. The idea that one can cut left tail risk is an illusion that in itself creates a greater risk. As Phil says, it also cuts right tail return.

Jeff Watson concurs:

Risk can be quantified, assumed, bought, sold, transferred, created, subordinated, reassigned, split, delayed, diluted,  fragmented, hedged against, and layed off……. Risk can respond to some methods, but it is still risk, and is near impossible to eliminate.

Speaking of planning in general, Stefan Jovanovich adds:

I have quoted this before, but it seems worth repeating, if only to add a mite to Adi's wisdom. Planning in business is all very well, but the trouble is that your plan's assumptions always turn out to be works of fiction. As John Wannamaker said, "I know half the money I spend on advertising is wasted. If someone would tell me which half, I would very much appreciate it."

Vince Fulco concurs:

This quote has always seemed appropriate… 

Moltke's famous statement that "No campaign plan survives first contact with the enemy" is a classic reflection of Clausewitz's insistence on the roles of chance, friction, "fog," and uncertainty in war. The idea that actual war includes "friction" which deranges, to a greater or lesser degree, all prior arrangements, has become common currency in other fields as well (e.g., business strategy, sports). [Wikipedia].

Russ Humbert warns:

One of the hardest things to get people to see is that most people/businesses have a long term utility function but operate as if all risk is short term volatility.  For example, I work for a company that has a niche market and is privately held. The owner wants to pass this business on to his great-grand kids so each will be as well off as he is now.  He has only teen kids now. This niche has very little volatility of earnings and good ROEs. But this just encourages piling on the same long term risk, to minimize the short term risk.  That is: grow the core business, not diversify. We already have the leading player in this niche.  Barriers of entry: a learning curve, requires some marketing  nimbleness, and need for stable size and reputation.   However, long term this has  no good ending. Best case we double our market share and flatline growth. But many worse cases.  Bigger, deeper pocket competitor or many, learns our niche attracted by the ROE and stable vol. We are regulated out of the market. Products slowly go obsolete, replaced by Government safety net. We lose our reputation, etc.  See this in spades throughout the fallen out of favor or failed businesses, due to subprime mess.  Low vol high ROE business, until….  For the speculator this would be like choosing a strategy that 95% time gives "Alpha" in a beta model based on quarterly results of recent history.  But all the "alpha" is hidden because, 5% time it causes you to go broke or close to it.  It just hasn't happen yet, or recently.   Basically volatility as a risk measure can hide long term complacency defeating most utility functions.

Going back to the military aspect Bill Egan adds:

An interesting aspect of the fog of war is the common mistake of not reevaluating the plan often. A major cause of this error is that people confuse perseverence towards a goal (a good thing) with sticking to the particular plan they are using at the moment to achieve that goal. Criticism of the plan and proposing actual changes to deal with new information or uncertainty are considered as defeatism or disloyalty and the operationally fluid are smacked down. The no longer relevant plan is then ridden on to failure to a loud chorus of "yes, sir! yes, sir! three bags full, sir!" A pleasant sight if it is your opponent doing this but awful if it is your leadership. I have fond memories of serving as a company commander under a battalion commander who always asked us to tell him if he wasn't making sense and meant it. Good man. 

Phil McDonnell  enlightens:

PhilThere are many deep questions in Mr. Lindkvist's ruminations on Expected Utility Optimization.

My first comment would be that there are at least two distinct classes of utility function. The first class might be what can be called the Ad Hoc Class. This would include the questionnaire method of approximating one's utility function.

Other methods might be classified as normative, as in what one should ideally want to use for a utility function. As a well known example we have the Sharpe Ratio. This is based upon the normative idea that one should maximize expected return but with a quadratic penalty for increased volatility which is treated as a surrogate for risk.

The idea of using a square root function as a weighting for betting returns actually goes back several centuries to Cramer, a mathematician. His friend and frequent correspondent Daniel Bernoulli countered with the idea of a logarithmic weighting function, which is also what I espouse with extensions. Bernoulli's ideas were not translated into English until the 1950s and thus were lost to Western thinking until very recently.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008



VN _ AubMy first encounter with Victor Niederhoffer was through this Daily Speculations website. I had known of Victor by reputation through various columns written about him and his books. I began to send contributions to the website back in 2006 and they were published. I sent a personal email and shared this with him. I told Victor that what struck me was the common admiration we had for our fathers that he wrote about in his book. He replied and told me that he would be sending me an autographed copy of The Education Of A Speculator. When it arrived I opened it and on the front of page 1 is the inscription:

To Stephen Leslie in honor of our fathers. Victor Niederhoffer

This was the beginning of a relationship that I regard highly. So to honor our fathers I am sharing this. I hope that those who visit this website remember their fathers on this most very special day. I know Victor and I will.

Alan Millhone recounts:

AlanMy Mother is 86 and gave me a nice Father's Day card. My Wife gave me a nice card as well and so did my Daughter for Father's Day. My Brother is 12 years my junior and I sent him a card.

My own Father passed on in 2003 and I only wish that today I could have handed him a card as I did for so many years in the past. I noted with interest how the late Tim Russert visited his Father as best he could and I could tell he was a loving Son. Harry Chapin wrote a song many years ago about being too busy and your children growing up before you realize it. There are some of us who had their differences with their Fathers, but in the end you only get one real Father. Time is passing all of us by, make the best of what days left we all have.

Happy Father's Day to all of you.

Jeff Watson adds:

My father was, is, the most important role model I ever had. He shaped my character, and always encouraged me to think outside the box. He never doubted me when I embarked on my career in speculation. Education was very important to him, just for the sake of learning, and he insisted that I attain the highest level possible, which I eventually did. I went over to his house today, presented him with a nice card, and gave him a new "Big Bertha." Contrast that with my son, who I love dearly. He got up at the crack of dawn, and left for the other coast. I got a text message telling me he was over in New Smyrna Beach FL, surfing. No mention of Father's day, no nothing. I'm forgiving, seeing all he has gone through, but, needless to say, a bit saddened. 



J SogiKaizen is a Japanese concept which means continuous incremental improvement. This is a process in contrast to and in disproof of the idea that outliers alone form history. It is the tortoise and hare issue. Incremental and thus compounded gains allowed Toyota to become the largest car maker in the world. This kind of steady gains over time arguably has been responsible for more and greater changes than the discontinuities. In markets it is the idea that it is hard to beat a buy and hold over the centuries. The slow advance of human records over years is another example of incremental improvement. For traders a steady improvements in skills, new and changing techniques to adapt to ever changing market cycles and a steady return is a good alternative to a boom bust methodology.

The larger brokers such as Lehman use up to 25-35x leverage. Banks are leveraged up to 20x with less than 5% capital. The common historical variance in any particular market should lead to some big swings in equity. The real estate market would similarly be leveraged at least 5-10x or more with a 10-20% down. This level is like the "Mexican option". The levels seem to be coming down now. This is affecting market action.

Scott Brooks dissents:

Scott BOutliers may not "form" history, but they do lead it. The outliers in history are the ones that led the way to new and innovative change. Whether you look at outliers like Alexander the Great, Hitler, Churchill, Washington, Charlemagne, or Ford, Rockefeller, Edison, Morgan, or Shakespeare, Van Gogh, Picasso, Beethoven, The Beatles. It's the great ones that lead the direction or show the way. Society as a whole makes a decision, in the form of many individual decisions, to follow the lead of those that are paving the way.

There is no question that society as a whole benefits and moves forward in a buy and hold methodology. But the great ones lead the way and change the course of mankind….whether on purpose, or by accident.

Are the moves of these great leaders a mere function of chance? Yes and no. Greatness is predictable, it's just not known where it will come from or the impact it will have. Just as one can't predict the outcome of a horse race of a coin flip with 100% accuracy, we do know that the coin will land with some result, and that some horse will win the race. These horses are the one's that shape history and direction, just as the great (or infamous) leader have over time….which has lead to the incremental progress of the human race. But the fact that some men have greatness is less a function of chance and more a function of an ongoing decision process. They each, literally, decide to be/do something and work towards that goal. There is no chance in a pursuit of greatness or a goal. There is no greatness in a winning a lottery, only chance. Achievement of greatness is not about the result achieved, it's about the process one followed to achieve that greatness.

I believe the same is true from trading. We all can make progress if we're willing to work towards that goal and learn from our past experiences and build on those experiences as well as the experiences of others that we learn from. Greatness comes from process we learn over time and in the falsification of beliefs that we hold to move towards a higher truth.

Average and ordinary people don't want to believe in something new. They want to continue to believe that the earth is flat or the that universe revolves around the sun. It takes a great man to falsify those beliefs, and move the whole of mankind in the direction of greater enlightenment.

Riz Din concludes:

The interplay of outliers and incremental change over the long course of history seems like a very natural process, although sometimes I pray for the outlier to arrive quickly and disrupt the state of affairs because incremental change has led to bloatware, bloated institutions, etc. that are riddled with inefficiencies. When the incremental path is followed, things get embedded in such a way that there is no way of overhauling the system and it takes a competitor to do what is necessary and start over from scratch.

Here is an interesting Economist article from my archives on the topic, it is from the excellent, Millenium edition (Dec, 1999), and discusses living standards over the past thousand years in the context outliers leading the way, incremental change, and our benefiting of compound return of growth/living standards.

Take a look at the chart.

In our life-times we see steady year on year growth and improvements in conditions and view this as normal. However, the author of the article notes, "material prosperity has risen more in the past 250 years than in the previous 10,000. And so conditioned to growth have people become that most westerners now expect their standard of living to improve automatically year by year; if it does not, something is wrong. This taking for granted what would once have seemed miraculous is the measure of the change."

Jim Sogi tries to get the last word in:

The Economist article Riz cites falls for the recency effect, that recent events are more important. Not so. The invention of language, the wheel, fire, tools, iron, writing, and printing presses probably surpass recent inventions in creating better prosperity advances and change. 



VN1) It had always seemed to me that the big differential between the rate of interest on the high yield debt, leverage buyout loans and mortgages and the treasury bond rate was a silver lining to make all the assets owned by the banks quite profitable even in a recession. Say they were earning 10% nominal on those assets with a 10% default rate of 10%. That was still 9% , and much more than the 3% available on treasuries or the fed funds rate they needed to borrow at. But now, the treasury rate is creeping up to 5% , and the differential doesn't look that attractive.

I always look at simple things like that.

My favorite mantra for fixed income has been that when the Fed makes tightening noises, this is very bullish because it keeps the long term inflation rate down.

I believe that's worked for 30 years or so, but now the interaction with the staggering amounts of leverage on the banks balance sheets adds an additional layer of complexity.

still with stocks reeling again, no way can the Fed raise interest rates as this would precipitate more problems in the differential that would truly create a lack of profitability on the income side as well as a weak balance sheet.

One realizes this is simplistic reasoning and would appreciate feedback on how predictions and tests and profits might be considered.

2) When in the merger bus in the 70's , we ran into buyers saying all the time " Why should I pay more than book for a company like this as it cant earn a return on its assets any better than average, and its activities could be duplicated. Much now seems to be clear about the brokerages and related financial institutions . Its clear that the relatively high rates of return on equity that they made, were because of high leverage and there was a corresponding low return on assets. Now that the assets have to be reduced, one is left with a ratchet brining both the bas assets and the return figure down. The Wall Street Journal in an article on Lehman says. " until Leh can prove that it has a future and find a way to regain lost investor trust, there is no reason to see why the shares should tradve above ( adjusted discounted book). Or why a potential buyer if the firm decides it can't survive on its own should pay much more ".

That's exactly what the potential buyers of companies in industries that were selling below book in the 70's used to tell me. The situation exacerbated by higher interest rates, so interest rates must go down considerably so that the problem is solved.

One realizes that the stable door is being locked late here, and that's why I concentrate on the interest rate prediction. The stock market vigilantes must show the world that interest rates must come down soon. 

John Floyd adds:

I was recently invited to speak to the ECB in Frankfurt. Below are some of the key questions I raised for them as they address the challenges going forward. I also gave them an investment example from 2001 which I thought was fitting given the similarities are remarkable with the current situation, oil/food have been substituted for mad cows. Given the singularity of their mandate and the fixed system they operate in I think the challenges are formidable. Milton Friedman does a much better job than me at recognizing this, and for anyone interested I suggest you take a look at his writings on the topic.

What is striking about much of the central bank rhetoric and action over the past year or so, particularly the Fed, is the extreme swings in the views, incorrectly in many cases. Along with that the investment houses have been wagged by the prices in changing their views, i.e. the changes yesterday by some banks for Fed tightening shortly.

Given the dynamics of what is happening on the banks, credit, and real economy it seems unlikely the central banks will tighten to the extent priced by the markets (+100bp by the Fed in the next 6-8 months, etc.). As the ECB has done in recent days expect some backtracking from the Fed, especially if the USD and oil calm down a bit.

Some more quantitative testing of these ideas and the resultant trading opportunities is probably warranted.

Some Key Issues Presented to ECB last week

Macro Economic Picture How does the European economy withstand the multiple external shocks that it is being exposed to? For example, the large appreciation of the Euro, substantially higher oil and food prices, credit problems facing European banks, and a significantly weaker United States economy.

The challenge of the Euro area is that some countries need higher rates to slow inflation (France and Germany) while others might need lower rates to offset the effect of housing slowdowns (Ireland and Spain). How is the circle squared? What are the prospects of expanding the Euro area to new members?

FX Is there a competitive problem with a strong EUR, especially versus CNY? What are the chances of intervention and what would the outcome be?

Inflation Primary attention is given to keeping inflation below 2% target. Does a slower European economy bring inflation down from 3.5% to target? What sort of gap is needed between the product and labor market to achieve the goal?

Credit How does the credit crises affect European Banks? And how might it impact lending behavior? How large are the losses and why does the pace of recognition seem to be slower than in the US?

Lending Window Are there limits to the lending to banks in places like Spain with real problems because of declining housing and foreign borrowing?

2001 rate trade

In Q1 of 2001 the prevailing market view was that the ECB would continue to tighten monetary policy given inflation above the 2% target. One of the great concerns of the ECB was that wage pressure would intensify over the course of the year, thereby placing upward pressure on prices. The ECB was concerned that with unemployment around the level estimated to be full employment (8.3%) above trend growth (estimated at 2.5%) would lead to accelerating wages. In contrast, it was the fund's view that the most likely outcome would be below trend growth, and the increase in inflation was largely attributable to sharp increases in food and energy prices. Regarding growth, the reasons it was expected to lag were two-fold: first, the slowdown in the U.S. would be greater than commonly expected and exert a negative force on Europe, and second, surveys indicated that consumer and business confidence were falling across Europe suggesting a sharp deceleration in domestic activity. For example, the expectation sub-component of the IFO survey pointed to sub 1% growth over the year beginning in the fourth quarter of 2001. Importantly, growth in this range would cause the unemployment rate to rise above the full employment level, with the consequence that wages would withdraw, not add, to inflationary pressure. As this outcome became apparent, the ECB would become more confident that inflation would fall below target and ease monetary policy. In terms of inflation it was believed that food prices were event driven, due to foot and mouth disease, they were not part of an inflationary process. Energy prices were expected to go lower as global economic weakness would exert downward pressure on prices throughout the year.



MLThe Practitioners, The Quant and The Nobel Prize were the speakers at todays finale of the NasdaqOMX Derivatives Week in Stockholm. You probably know them better as Denise Hubbard (20 year options trading veteran from the Chicago trading floors, that has traded for Dean Witter among others), Dr. Espen Haug (expert on derivatives, serial book writer on options and former trader for JP Morgan and several hedge funds), Dr. Emanuel Derman (of "My life as a Quant" fame, co-developer of the Black-Derman-Toy interest rate model, and former Managing Director of Goldman Sachs), and of course Dr. William F. Sharpe (winner of 'The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, 1990', and the STANCO 25 Professor of Finance, Emeritus, at Stanford University's Graduate School of Business.

Dr. Haug started the day by talking about fat tails, past, present and future. Among the most interesting part of his speech was his alluding to having in the drawer some theories on new distributions and implications for option trading. But he didn't go further on the record but said that he would probably write a bit about in on Wilmott. His gave a very good speech, so I for one will definitely be on the lookout for his findings.

Denise Hubbard. It is always gratifying when somebody of great practical experience shares their best do's and dont's. Ms Hubbard shared from a wealth of knowledge in a speech called "School of hard knocks - lessons from the trading floor". Great advice mixed into funny stories from the floor, and off, since she has made a successful transition off the floor and trades from the screen nowadays. "When 'extraordinary popular delusions and the madness of crowds' takes over, mathematical models go out the window" was one of her rules which she then expanded on. Reminded me of Chair quoting Aubrey "never mind the maneuvers, just go straight at them".

Dr. Emanuel Derman came across just as unassuming and nice as I thought he would be from reading his book. Funny too. His speech drew on some material from the book and was about valuations and its discontents. A lot about the failure of models. He concluded with some thoughts on the right way to use financial models and one quote that stuck with me was: "use vulgar variables but in a sophisticated way". I take it to mean that one can get much mileage from quite simple tools or models, as long as one put a lot of thought into HOW to use them.

Finally, and the grand finale, Dr. William F. Sharpe talked about asset allocation looked at from a bigger perspective than mean/variance optimization. The gist of the speech was that if people really just care about those two measures, then fine, mean and variance is good enough. But people usually have more wants and needs. By getting them specified you can draw up utility functions and use them as a basis for the asset allocation (very simplified by this correspondent). Very interesting speech, and it will be interesting to see if this will have any effect on how endowments and pension funds, for example, actually allocates money. There was actually one in the audience*, that had the audacity to ask Dr. Sharpe if there was any interest from practitioners, and if the new model is being used/will be used. He said that it was too early to say, but at least the article had won a prize, so there was at least hope. (*yes you are right, it was this spec list correspondent that asked the question….what can I say, they gave away a baseball cap to the first in the audience that asked a question so I had to spit something out)

All in all, a very interesting day, which ended with drinks and horse divorce, and all smiles (excuse the pun).



Kim ZIt's notable that many of the wealthiest investors are optimistic. But not all of them are, and certainly pessimism pays well from time to time.

Assuming there is a payoff to optimism, what if Penn's Dr Seligman (optimism can be learned) is wrong, and optimism/pessimism is - like many personality traits - genetically determined and rather immutable? Inherently optimistic investors get the rewards of their fortuitous place in time, when they are fortunate to be placed in times of fortune.

Dr Goulston's recent post about personality types suggests there must be studies on which personalities are suited to trading financial markets, and which not. There are lots of these tests - you can take one (such as  this Myers-Briggs type test) and then ask whether your successes and failures were predetermined.

In any case, haircuts never go out of style, they just change in type (remember the old song by Crosby Stills Nash and Young).

Riz Din adds:

My optimism is partly a function of recent documentaries watched, but it looks to this layman that even if mankind is only equally as clever as they have been in recent years, then the gains to humanity will be breath-taking as the digital revolution becomes all encompassing.

Instead of observing incremental changes in technology lets remind ourselves of the state of the world a just few decades ago. Thinking back, I remember adding a 32k ram extension on to my ZX Spectrum. Today, you can pick up an 8GB portable thumbdrive for under GBP 10. I won't try and calculate the gains that have taken place, but I'm pretty sure that if progress simply continues as is, the world is going to be a very interesting place. As the digital world widens and reaches into other fields such as genetics, and perhaps even energy technologies, these fields will reap the benefits of rapidly increasing processing power and depreciation that ensures wide affordability. I can't wait to see what innovations emerge in coming years.

Esteemed former intern Jan-Petter Janssen (NEPS '06) writes in:

If you define optimism as the tendency to overestimate the probability of favorable outcomes, it is clearly irrational and should be avoided. However, it is a good antidote to another unwanted bias; the propensity to suffer mentally from losses more than you benefit from gains (a  la Kahneman-Tversky.) [The latter may not be irrational, but is clearly not a good way to think for a successful-to-be speculator.]

A (too?) much used tool in finance is to compare the utility you gain from a certain outcome versus the expected utility if you choose to take risk. I will apply this to a social setting all guys have to (or had to for the lucky ones) deal with: Should you ask the most beautiful girl out for a date? A Kahneman-Tversky mindset would suggest no action too often because of the fear of rejection. Optimism has the opposite effect of course.

More generally I believe optimists choose action (i.e. risk) over inaction (i.e. status quo) more often than pessimists. And from my own experiences; it's the losses, humiliations and embarrassments that in retrospect have made me fight back and grow … while much success, although good, sometimes lead to hubris and a personal bubble to burst. The bottom line is that action is usually better than inaction. So triumph of the optimists!

Vic observes:

There has been a most unusual clustering of big minima in the S&P recently. Naturally this clustering has been followed and coterminous with all sorts of negative news. Those who are short have not been reluctant to discuss their positions before the close in interviews. The word "ideal" comes to mind.



CoffeeA few years ago, I read "The World of Caffeine: The Science and Culture of the World's Most Popular Drug" (Weinberg & Bealer). I took a few pages of quotes, which is a good thing too, because I can't remember a word of it. Following a re-read, here's a selection of quotes:

Hahnemann argued that, though caffeine allows you to burn energy more quickly now, you will suffer a corresponding letdown later, initiating a debilitating cycle that is ultimately less productive than staying on an even keel by abstaining from caffeine altogether. As he states, coffee engenders an "artificially heightened state of being…Presence of mind, alertness, and empathy are all elevated more than in a healthy natural condition." These apparently benign effects, he says, disturb the natural cadence of the biological system, which depends on the alternating rhythms of wakefulness and sleepiness.

Coffee and tea have given rise to a great duality. …Coffee has become associated with all things masculine and with the artist, the nonconformist or political dissident, the bohemian, even the hobo, as well as the outdoorsman. It is often considered a vice, its consumption linked with frenetic physical and mental activity, intense conversation, and with other indulgences that threaten health and mental balance, such as tobacco, alcohol, and late nights of hard partying or excessive work. Tea, in contrast, is associated with the feminine and with the drawing room, quiet social interaction, spirituality, and tranquillity and is regarded as the drink of the elite, the meditative, the temperate and the elderly. These differences between coffee and tea are easily seen by comparing the rough and ready institution of the coffeehouse with the decorous traditions of the Japanese tea ceremony and the English afternoon tea. An acknowledgement of these differences must underlie the fact that, although coffee has been the subject of many bans and opposed by many temperance movements, tea has rarely, if ever, appeared on anyone's list as a substance that ought to be put beyond the pale of law or morality. The more it is pondered, the more paradoxical his duality within the culture of caffeine appears. …It is true that coffee is generally brewed to a caffeine strength over twice that of a typical cup of tea, yet, because more than one cup of the beverage is commonly consumed, there is no doubt you can get a full dose of caffeine from either one.

In the 1970's, largely as a response to reformational grumblings stirred up by concern over an unsubstantiated link between caffeine and pancreatic cancer, Coca-Cola and other purveyors of dietary caffeine set up an funded the International Life Sciences Institute (ILSI) and its public relations arm, the International Food Information Council (IFIC), both based in Washington D.C., to help forestall any efforts to regulate or ban caffeine.

Because caffeine is water soluble and passes easily through the cell membranes, it is quickly and completely absorbed from the stomach and intestines in to the bloodstream, which carries it to all the organs. This means that, soon after you finish your cup of tea or coffee, caffeine will be present in virtually every cell in you body. Caffeine's permeability results in an evenness of distribution that is exceptional as compared with other pharmacological agents; because the human body presents no significant physical barrier to hinder its passage through tissue, the concentrations attained by caffeine are virtually the same in the blood, saliva, and even breast milk and semen. … One of the secrets of caffeine's power is that caffeine passes through this blood-brain barrier as if it did not exist.The maximum concentrations of caffeine in the body…is typically attained within an hour after consumption of a cup of tea or coffee.

Because caffeine passes through the tissues so completely it does not actually accumulate in any body organs. Because it is not readily soluble in fat, where is might otherwise have been retained for weeks or even months, as are other psychotropic drugs such as marijuana. For most animal species, including human beings, the mean elimination half life of caffeine is from two to four hours, which means that more than 90 percent has been removed from the body in about twelve hours.

Cigarette smoking doubles the rate at which caffeine is eliminated, which means that smokers can drink more coffee and feel it less than non-smokers.

Caffeine eventually devastates the plants that produced it, for as caffeine-bearing bushes or trees age and the soil around them becomes increasingly rich in caffeine absorbed from the accumulation of fallen leaves and berries, it eventually attains a level toxic not only to microbial enemies but to the plant itself as well. It is partially because of this toxicity that coffee plantations tend to degenerate after ten or twenty five years.

And from an Economist article: "Coffee Houses", December 2003

According to custom, social differences were left at the coffee-house door … and anyone who started a quarrel had to atone for it by buying an order of coffee for all present. Richard Steele, the Tatler's editor, gave its postal address as the Grecian coffee house, which he used as his office. In the days before street numbering or regular postal services, it became a common practice to use a coffee-house as a mailing address. Regulars could pop in once or twice a day, hear the latest news, and check to see if any post awaited them. That said, most people frequented several coffee houses, the choice of which reflected their range of interests. A merchant, for example, would generally oscillate between a financial coffee-house and one specialising in Baltic, West Indian or East Indian shipping. The wide ranging interests of Robert Hooke, a scientist and polymath, were reflected in his visits to around 60 coffee-houses during the 1670s.

(And here are a few pictures of spider web construction after the spider has been exposed to various drugs, including caffeine).



KSG1) The two most amazing things about the decline on Friday were that it was the worst Friday ever (down 45.80 in S&P futures) after an up Thursday, and that the Chairman, who talked at Harvard on Wednesday about the soundness of the economy, apparently didn't have the number in hand, as I have always treated his utterances as if he knows the next announcement at least three days in advance. The Kennedy School once bought a million + cache of vintage refreshments and presumably a similar effect must have caused the lapse. Of course, the teenage employment aspect is just one more fly in the ointment of the usual random numbers that greet the employment report, sure to be reversed on a statistical basis by the next random number which starts out with a strong bias from regression to mean effects for levels.

2) No wonder Visa and Master Card are up 100% over the last year. Apparently they're predicting 20% a year growth in credit card use as other countries and affinity groups increase their use of credit. Its now "debit or credit" rather than "cash or check." I was particularly interested in all the companies catering to the credit card companies as they would stand to grow as the epyphytes do on Google. Such companies as Total System Services and Heartland Payment Services, Fidelity National Information Services, which do the paperwork for the credit cards. The analysts make much of the fact that the credit card companies don't take the risk on their transactions but pass it on the banks. And certainly the paperwork companies would seem to be doubly removed. They seem like good buys relative to their growth prospects, and the adage that they do lead in the recessions and lead in the recoveries should be tested as should the similar phenonenon for brokerage companies. I was fortunate to be thrust into this line of thinking by having my credit card stolen when a park office would only issue me a $10 permit if I paid by credit card. The next day someone used my number for a four-figure purchase. Apparently thieves have cameras that can scan the front and back of credit cards. They have to go up against the security companies that can match every transaction at a cash register to a photo ID, even months later. The ingenuity of the credit card thieves, as underlined by a recent article in Boardroom Reports, is impressive.

Even more impressive to me was the followup that the biggest credit card company came up with. When I called, an agent offered me a big loan at 1.75%. After putting me through 15 minutes of identifcation they noted the fee was 3% sign-on. When I remarked that I would have appreciate they telling me that at the beginning (I never lose my temper, after 10,000+ competitive squash matches), they immediately dropped it to 1% and offered to qualify me for a bigger loan. They put me through a five-question credit scoring test based on cash flow and occupation ("speculator.. I mean, executive").

The flexibility they show in price discrimination, and reducing consumer surplus, and gaining a customer with a short term premium was impressive. Combined with their projected 20% a year growth, as "credit or debit" rather than "cash or check" becomes the new mantra, they seem to have many of the elements of a good business.



As to the hydrogen production issue, doesn't it shift our reliance to coal, instead of oil? Yes, its domestically sourced, but also beset with similar (worse?) carbon emission issues as petroleum…

Michael Ott replies:

Mike OttHydrogen can be produced from coal, but it's very nasty to the environment and will eventually run out. Biomass is a much better source because it's renewable and available in massive amounts (1.3 billion tons per year, according to the USDA). Biomass can be converted into both liquid and gaseous fuels and will be the bridge to the hydrogen economy. This is why funding ethanol research is important. First you make it from something easy, like starch found in corn or sugar cane. Then you make it from something available in much larger amounts like wood, corn stover, or other ag residues.

One of the main advantages of making ethanol from corn is that the logistics for storage and transport are well established. Plus there is a lot of sugar which can be easily accessed by existing enzymes. The logistics of moving around large amounts of biomass are not well known and will require large amounts of infrastructure. It will be built because infrastructure is always built to support a better and cheaper fuel source. Cellulosic enzymes are also getting better, improving 30X in the last 5 years. The same infrastructure will be used for gasification of biomass, which will produce the massive amounts of hydrogen needed to drive an economy.

This is why I'm optimistic about biomass. Currently, you can make about 80 gallons of ethanol/ton, so the potential productivity is 104 billion gallons. The US consumed 142 billion gallons of gasoline last year, so there is potential to replace a significant chunk of gasoline. Assume that efficiencies will increase to 100 gallons/ton and that dedicated energy crops provide 1.5-2 billion tons/yr, and theoretically all gasoline could be replaced. Obviously not all will be converted, but the potential is there.

Addressing Stefan's points about energy efficiency — Assuming that the sun's energy is free (which it is because it will shine the same on a parking lot as a cornfield), the efficiency of ethanol is 1.4 : 1. Gasoline is 0.88 : 1. The economic efficiencies are much more important. Right now ethanol is much cheaper to produce than gasoline and will be competitive down to $40-50/bbl oil. Both ethanol and gasoline are heavily subsidized, so economic arguments are tough to make. If all subsidies and credits were removed, ethanol and oil would be roughly equally priced at $30/bbl (maybe a little higher due to recently raised corn and nat. gas prices).



The Inka Trail travels 47 km though the high Andes, on the edge of steep cliffs thousands of feet straight down, surrounded by majestic glacier covered peaks, rising over 4 thousand meters through steep passes, and Indiana Jones like hanging bridges over deep chasms with rushing rivers and though paths carved though solid granite stone with steps chipped out of the mountain itself, through high tropical jungles, with ancient ruins along the way, along side gurgling mountain rivers with ancient aqueducts crossing a regular intervals, culminating at the Sun Gate overlooking Machu Picchu. The trek is not for the the timid or weak, but did provide time for thought about many things including ideas about the market, up ward drift,natural philosophy, and life. Here are a few thoughts.

Big Tree Trade.

The trail is surrounded by a rich profusion of plants, reptiles, lichen, fungus, epiphites, orchids, mosses, bromeliads, trees, insects, birds, and rich geological features. All compete in the thin Andean high altitude for sun that peaks between the steep valleys and crags on rocky scratchy soil. A few large trees take a foothold on the steep steep mountain sides and protrude up through the jungle thicket. A profusion of life clings to the tree, all wrapping around the tree, the birds nesting, creating a whole ecosystem on the tree.

As the market follows nature a groundbreaking protruding company, such as Google that gains a foothold, protrudes through the thicket and dominates its space. To it clings a profusion of companies supported by the groundbreaking space, the new technology, allowing access to new markets, new opportunities. companies such as wine racks, face book, others that cling to the use of the new technology, and similar that will grow up big, fast on the back bone of the big tree. I have not tested this but welcome some ideas for small companies that might grow on the back of Google's spine.

Walking Palm and Agave tree trade

Another nature oriented trade was inspired by the Walking Palm and Agave tree which appear in the deep amazonian jungle and the high Andean high jungle. The principle of propagation is similar but the pattern may be different. The walking palm has many long roots that stick up about 1/3 the way up its tall thin trunk in to the soft wet mossy ground of the jungle. As the top of the tree leans one way or the other to seek light seeping through the high canopy the roots on the far side let go, and the new roots grow out to support in the direction of the tipping trunk allowing the tree to walk towards the light. Some quantification of the speed of this action,, the proportions, and movements and angles might give some ideas about the natural progression of price growth in the market as it seeks new light, new energy, new money in it progression an growth.

The Agave propagates from a short dense sharply pointed bush and the when its energy has built, it sends a long tall shoot up 3 or more ( need to count this) times the height of the bush. The shoot is covered with seed pods that tip the long tall shoot over and as the shoot tips over, the packs of multiple seed pods land some distance away from the parent bush and propagate new the plants and new shoots in time. My impression of the current market is like the Agave tree. It tipped over Friday today, but in due time, the new seeds should propagate and send up new growth Quantification might include measurement of the height of the stalk to the bush, the number and weight of the seeds, and the propagation rate to discern how such a similar phenomenon might manifest itself, if at all, in the markets with any regularity that way that nature seems to manifest such regularities.

Upward Drift

Many pleasant hours strolling with the family in the lush high jungle forest on a precipitous narrow trail overhanging on the side of thousand foot cliffs chipped out of solid rock by ancient hands leading to fantastic science fiction like looking ruins set atop high abutments above precipitous peaks, viewing vertiginous valleys and glacier capped peaks, waterfalls, fountains and streams gave time to think and consider the applicability of the upward drift to individual trades, individual traders, civilizations, species and evolution. Certainly there is upward drift in evolution and in civilizations. The question is how can the trader profit from this? The Inkas' had a large and glorious civilization, but not so great that it is now reduced to a mere set of rubble tourists see and the shadow of an empire lives off. The Spanish helped the fall, but the Spanish had their fall shortly thereafter. The British had their upward rise, but now have a shadow of their former glory and empire. Evolution of species drives upward betterment, but evolution itself is the story of extinction. Companies rise, but few of the Dow are the same as they were, or the Nifty Fifty. How is a trader to beat buy and hold with leverage? Study of the outliers, dips, crashes and valleys, extinction is a key. On the plane ride home, The Expert's tome on the subject will provide much more food for thought on the effect of, the reason for crashes, and outliers, and the various asymmetries in the analysis which will be covered in a subsequent post.

The Pace on the Trail

The Inka Trail rises and fall over many thousands of vertical meters over mountain passes on its journey to Machu Picchu. It eventually ends up lower than its start. The climbs are grueling cardio climbs that push the climber to the limit of sustainable heart and lung function. Each climber has an individual pace. The best advice is to follow your own individual pace. Too fast, and the climber starts to huff and puff, and pant and soon must stop losing progress. Fast runners, BMX'ers, and fighters know this. Too slow for some reason causes exhaustion or frustration as well. A group of English tourists walked too briskly, then starting to pant, had to stop too often to rest and catch their breath. For this trekker a very slow but steady pace allowed an equal or better overall progress. Some groups felt the need to walk together, but the varying capacities of the individual members created tension, and progress overall slower than splitting into individual paces with set rendezvous points. It can feel really ridiculous to step, take two breaths and step, but arriving at the end of the trail feeling strong and whole is the ultimate reward for the tortoise.

Each trader has a pace at which he performs most comfortably, which should be considered and which will allow the best overall performance. It is the heart of the tortoise and hare parable. The life of an investor and trader should be long, a lifetime properly. There should be consideration of pace in the traders vocabulary. The idea is not completely captured in risk tolerance or return and encompasses a longer term view of the journey.

more later…



 We have learned that Ken Smith, a frequent contributor to this web site, passed away on June 2, 2008 at age 78 (of an apparent heart attack).

Ken travelled to many places over his life, was involved in all kinds of interesting situations and shared many of them with us through his writing. Several of us had a chance to meet him in person as well.

Our condolences to his wife Ina.

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Andrew Moe remembers: 

Here is my favorite post from a good friend who often gleaned remarkable insight from the wonderful life he led and was generous enough to share it with us. A true Spec.

####### Original Post by Ken Smith #######

At 6 am I looked out to the front lawn and observed a lone American Robin listening for worms and insects in the dew-moist grassy ground. The bird shuffled from point to point in a random-appearing change of direction. This is breeding season; the birds are now carnivores. After breeding they will switch to a vegetarian diet. The Robin was patient at each stop, giving his senses time to pick up the signals nature has programmed him to use in his search for food, food which furnishes him with reproductive energy. He has arisen early and discovered this niche for himself, my front lawn, recently watered.

A signal from the ground is perceived and Sir Robin quickly has his prey, no hesitation. This guy is an active hunter, as in active trader. His little computer brain and sense organs are crawling the field in search of prey, a morsel to fatten his resources. Sir Robin will switch to another lawn or playground or marsh when his present search produces less energy than the energy required to do the search.

He will fly away, perhaps randomly choosing the next site for exploration. When breeding season is over, the eggs hatched and nurtured, Sir Robin will change his diet preference. And the turning of the earth, the sun, and the moon will influence him to change his territory, his environment, his location in relation to these planetary orbits. A trader seeks a niche, as the good Doctor Niederhoffer has suggested. Sir Robin, as an epitome of nature's example, has a bird brain yet survives, breeds, and flourishes. How complicated do we need to be to survive as traders?

"Once breeding season is over, the sweet-singing and familiar robin of our backyards becomes more furtive and shy. Large nomadic flocks form and range over the countryside in search of berries such as mulberry, sumac, grape, viburnum, and cedar, as they shift from their breeding season diet of insects and earthworms to become wholly vegetarian. By September, many are moving south from the northern parts of the eastern half of the country to winter with southern residents in the Middle Atlantic and Gulf states. In the West, Robins wander broadly in search of food and move generally to areas of lower altitude. But some linger as far north as Canada when food supplies are adequate, so the first robin you see in spring may not have come from too far away." (Cornell U. ).



Whenever knocking a hat off I feel, and want to tear the weekly paper to pieces, and lash out at all the nabobs,  I don't take me to Nantucket but read "The Surprise" by O'Brian. There I find a passage about how the hands like to pretend that the ship is about to go under with the non-mariner dignitaries, and how the water is going to sink it, if not the waves or the backlash. It makes me think about the reasons for all the negativism. Is it the insiders trying to scare the daylights out of the public like the mariners? Yes. What difference does it make if the economy is down 1/2% this quarter and goes up 4% a year the next several years? Or what difference does it make that there was a housing recession the worst in 25 years. Or that the financial institutions had much water on their balance sheets. Such has happened before in the last 100 years, and is it bullish or bearish when all this negativism is about. One needs a Jack Aubrey with his natural ebullience to see the sweet sailing ahead on the blue waters that beckon.

Tim Melvin replies:

It makes all the difference in the world for any of us who wish to bet on US stocks… unless we are capitalized to withstand a 20% or more drawdown in stock prices. it especially matter if you are using any leverage at all (and yes I counted it. The average peak to valley drawdown in stock prices in a recession is on the order of 30+%. we have not even come close to the 1000 SPY levels that would be normal. The last time we had stagflation, the market fell over 60% peak to valley) There will indeed be blue skies ahead someday… the question is when? The combination of a falling economy, falling real estate and higher food and energy prices is crushing the consumer. If consumers do not buy luxury items, go out to eat, to the movies or even replace wardrobes, household items and even wardrobes, the companies that make these items, the retailers that sell them, and the companies that supply raw materials have lower profits. They cant borrow to make it through bad times and the water on bank balance sheets has tightened credit.

Loathe as I am to ever be opposite to one of the men I most admire, I think that most stocks are a poor bet right now. yes we will cure cancer, technology will advance and the long term future will be bright indeed. But not right now and reality is still not priced in the stock market. The dollar gets it, and bonds are starting to. The storm must pass before the sailor can safely leave the harbor. One caught in the storm must batten down and hope to ride it out as safely as possible. many , if not most, of those who ignored the warnings of wind and tide may well perish. Not even Aubrey would sail into the typhoon unless he it was a matter of the greatest urgency. As investors and traders we have one supreme luxury. We do not have to leave the harbor, and can profit by betting on the typhoon once in a great while, or simply sail a different sea.

Vic illustrates:

Here is a passage from The Surprise: "The envoy, Stanhope, had been told that water was coming in through the sides, and a seaman had told him that this was the gravest sign of all. One of the young gentlemen added that being pooped was more likely than actual foundering, or breaking in two, though neither possibility was to be overlooked. " Stephen said "The water coming in was inconvenient and even disconcerting but it was a usual phenomenon in such circumstances, particularly in aged vessels: It was what the mariners termed "the working of the ship." And be cautioned against too literal a belief in the words of the sailors: "They take an obscure delight in practicing upon us landlubbers". Once relieved of the sensation of imminent death, Mr. Stanhope…. ". Yes, the delight the brokers take in downgrading one another, and spreading rumours of runs, and trying to run the nakeds up again as they did the last two Springs, is not too innocent, but calculated to gain increased emoluments from the government and their future colleagues at the Board, and increase their share of the prizes as the landlubbers abandon ship.

Russ Humbert writes:

Perhaps it is no coincidence that Lehman, Merrill and Morgan Stanley, having received a review from the rating agencies that downgraded but still maintained their excellent ship worthiness, that the shorts would be emboldened. After getting so much wrong on the mortgage backed front any affirmation from them is similar to an endorsement from Bush's foreign intelligence chief on Iran. And perhaps it is no coincidence that Merrill, was the first to come out stating the shorts are full of hot air on Lehman's because they see they are next in line.

It will be interesting to watch for confirmation that Ben's revival meeting with all the investment banks included thinly veiled threats to those Investment Bankers who don't support their competitive brothers and reminders that  any piling on by them would be remembered for a long time. Was there a reminder that Bear Stearns did not help LTCM in 1998? Will Ben rally the troops? Will he speak in code? And how will the other brethren react? And will the SEC this time understand that their turf is in jeopardy and launch a full assault on the rumormongers, as they did on the  hyperbole of the dot com analyst? It has been my experience that a regulator fearing a turf grab is a dangerous animal backed into his own den with the hunter thinking he is cornered. And finally, could it be that the switch in NY governors will be the wind turning against those who believe their job is to protect us from big business without regard to method because size is equal to guilty?

The President of the Old Speculators Club, Mr. Tierney, issues a warning:

"Seems to me the greatest opportunities to make money going forward over the next 18 months to 24 months is to Short Gold, Short Oil, Dollar Cost into Equities as always, Long Dollar" - A reader of this web site

An interesting observation. In that it's been almost exactly 7 years since I announced the dumping my entire portfolio except for a couple of resource stocks, some retrospection is in order.

A recent post lauded the performance of IBM, hitting a multi-year high of ~$125. More recently, AXP was commended for its performance around $45. Those were among the equities I cast overboard, IBM @ $115.04 and AXP @ $39.43. As of today I would have been up 11.47% with Big Blue and 18.67% with AmEx - not exactly stunning performances over seven years (especially if one were to calculate the effects of inflation).

On the issue of shorting gold it has been an idea promoted by various List members at various times over that same time span - they have been incorrect. The concept of overpriced oil harkens back to the build-up to the second invasion of Iraq, when it was posited that the price would go back below $35; similar pullback predictions have been scattered over the past five years - once again, incorrectly.

The long dollar argument was made most forcefully by Yale Hirsch and his imported and highly regarded currency-expert henchwoman. That dates back about three years or so and, again, was incorrect.

Now the drunk who insists on looking under the street light for his lost keys because it's easier to see, may, once in a millenium, find them there. That's just luck. However, how do we judge the many sighted Street "names" who, over an extended period of time, have groped in the dark but come up empty?

More important, to whom do you listen for guidance in perilous times: the babbling and infrequently lucky drunk or to the sober and calculating historical record? The answer is obvious. Unfortunately, as has been documented and repeated innumerable times, the Market Mistress does not do the obvious.

Nor does she (nor anyone else so far) prepare meals of crow.

J. T. Holley asks:

Do you really think that we are in perilous times?

Jack Tierney replies:

Yes, I do. But in fairness, that's my nature. While many look on the markets with unflagging optimism (Vic and Laurel , L.V. Gave , Dimson et al. ), I tend to believe we have lived at a truly extraordinary time in an extraordinary country. So extraordinary, in fact, that not only those with the courage and capital, but also those who've stood and waited at the right place, have seen modest sums grow exponentially.

I am one of the latter, caught up by events and carried with the wave. Others, through risk-taking and foresight, have done substantially better, and deservedly so. However, the last 60-70 years doesn't, in my opinion, establish an immutable pattern. Historically, our past century is an anomaly. There has always existed a self-selected minority which achieved wealth through courage and daring.

But these last two (or three) generations have been unique in that wealth has "trickled down." Enough so, unfortunately, that it has become politically correct to view abundance, if not affluence, as a birthright - and one which can legislated for those who have missed out.

In itself, though, that's not enough to make me skeptical. My profit sharing account took some real whacks in '73-'75 and again in '79. I was fortunate enough to be in cash in '87, but got a minor haircut again in '91. I can live with oil crises, the slow motion crack-up of steel, autos, and aircraft. Technology, however it is defined at different times and different places, always ends up with more losers than winners.

But when major problems come out of the banking/finance sector, it's time to squeeze the pennies. Forget for the moment about those who have overspent and under saved. Instead, consider those financial institutions which have peddled gobs of their mortgage paper to pension funds, both public and private. By Greenspan's description, these are among those most able to undertake risk. In fact, they are not.

Much like myself, the memberships are made up of ordinary individuals who expect a modest sum to be available when they retire. If nothing is there, there exists no fallback positions. Already there are rumors of deficiency notices circulating… some involving major unions, others major metropolises. Jefferson County in Alabama is on the hook for over $3 billion in auction rate securities because JPMorgan and others sold them on interest rate swaps as a way to cut down on expenses.

In short, from the time of John Law, banking foul ups have had a much more severe effect on an unsuspecting public than any other business blunder. When bankers get it wrong, almost everybody gets hurt. So, yes, I'm concerned.

Stefan Jovanovich dissents:

I don't think the facts of American history support John's pessimism or his assumption that the years since the Great Depression have been uniquely profitable. The increase in wealth in the British colonies of North America from the end of King Phillip's War to the start of the Revolution was far greater per-capita than anything we have seen in the last 90 years; that is why there was an immigration boom that dwarfed anything the country has experienced since then. The period from the end of the Civil War to the passage of Smoot Hawley was equally spectacular as far as individual wealth in the North, Middle and Far West (but not the South) are concerned; and, once again, people literally flocked to the United States. Both periods depended on changes in technology that were - at least from the point of view of their effects on the rest of the world - far more dramatic than anything we have seen in our lifetimes. The improvement and broad use of Jethro Tull's seed drill was an agricultural revolution that equaled the effects of artificial fertilizer in our time, and the mating of steam power with Jacquard's loom turned India from a textile exporter to importer (with help, it must be admitted, from Britain's discriminatory trade rules).

John is right that, initially, "technology …. always ends up with more losers than winners" in the sense that machines replace people. But without that displacement no increases in wealth are possible. Socialism's real curse is that it kills all invention and change; in the name of fairness and equality Lavoisier's head is always the first to go.

The genuinely new and different improvement of our time has not been in wealth but in health. What the world has never seen before are the mortality statistics. Even with the devastations of the two World Wars and the results of Marxist national self-improvements in Europe, Asia and Africa, the change in the ability of people to be born safely, survive childhood and live long enough to suffer the diseases of old age and indulgence over the last hundred years has been breathtaking.

I wish I could share the assumption that the "public" - that anonymous sociological beast - has been duped by the evil bankers. Perhaps that has been true elsewhere in the country. But, from the point of view of California, the people who have borrowed money to buy dirt and houses and condos have been a great deal less unsuspecting than the folks who bought the securities that allowed the pyramid party to keep going. The borrowers knew they were signing for far more money than they could pay back out just the way anyone who could read knew during the Internet bubble that very few people were actually making any money from the brave new virtual world. In both cases the buyers thought it didn't matter; and, for a great deal longer than we supposedly rational business people considered possible, they were right.

My real quarrel is not with John's assumptions but with the premise that seems almost universal - namely, that bankers are still the source of enterprise capital that they were even a generation ago. Nothing that I know from direct experience or from studying the numbers for profitable non-financial public companies bears that out. We own common stock in 147 companies that do business in everything from shoes to lasers, and not one of them has relied on commercial borrowing or public financing as a significant source of cash since 2000. Of the over 100 independent business people I know here in California, the only ones people who have been able to rely on commercial credit from banks have been the folks dealing in real estate. Everyone else has been told no. Even SBA loans became dependent on the entrepreneur's having real estate that could be pledged as security.

Ironically, now that residential real estate out here is finally getting cheap enough to compete with rental prices and people with jobs and savings want to buy houses, the same bankers who issued ARM liar loans are largely unwilling to issue straight mortgages when the numbers pencil out. Having watched the Sandlers convert everyone to their cultist belief in appraisal values as the standard for credit-worthiness, most California lenders are now refusing loans because of their fears of what REO sales will do to future housing prices. The prospective buyers, who are offering to put real money down, are willing to take the risks; but the bankers still think they know the market better than people willing to put up most of their savings because they can buy a house for what it now costs them to rent an apartment.

The old bankers are always getting it wrong. That is why we end up having to find new ones.



KimStefan's recent post on his business reminded me of some recent ones about yields on investment and how to value a business.

If someone sold you a business for $1 million which over time averaged income of $70,000 per year, with some years much higher, some lower, and many losing quite a bit, you might wonder if you overpaid. That's the stock market, which is probably better considered an investment - not a business. A business is a system where the proprietor can have some large direct effect on outcome (income), and ostensibly be compensated for personal abilities and effort.

To a great extent, each person is a business; with various assets, liabilities, capacities, and reserve capital, as well as capitalization of barriers to access. Perhaps successful traders are rare because they compete in a system with few barriers to access (no degrees or licenses needed), and irregularly dispersed severe reward/punishment which restricts long term success to supernatural intellects and/or stomach for pain. By definition no obvious profitability is persistent, and by correlation few can adjust to an unstable reward/punishment schema.

Yet there are the undeniable attractions of heroic market figures, who bravely took huge risks to finance their opinions of the world, and got it right. Walter Mitty, had there been an Internet, might have hoped to make a fortune trading markets (while keeping his desk job).

If trading, what becomes of those attributes beyond using an iron gut to second guess a random system? A trader with people skills, charm, or good looks squanders these normally valuable assets yoked to the torture machine all day. There are lots of folks who make very good stable incomes, if for no other reason than that humans are social animals who will pay to feel better.

There seems no shortage of causes behind the data showing that a very small fraction of traders out-perform the market long term.



I have been listening to Hazlitt on my morning walks. Finished it this morning, and there he was in 1978, writing that politicians undermine the currency with inflation, which drives up the price of commodities. The politicians then decry the excessive profits being made by commodity producers and call for government regulation of prices just when new exploration and production are most needed.

The wheel turns again.



In discussing history the other day with a client he happened to mention, and educate me on, his family's losses in the Kuwait's Souk al-Manakh Stock Bubble of the 80's and the dabbling in foreign markets. He said that the lessons learned were obviously numerous and that the recent Dubai boom "to him" smelled of the same setting in other asset categories. Anyone remember this or have experience with such?

Greg Van Kipnis replies:

I remember it well.

The Kuwait Souk al-Manakh was an over the counter exchange largely designed for speculation by guest workers and immigrants. The official Kuwait exchange was off limits to all but citizens.

The bubble was financed by virtually infinite leverage. Speculators were allowed to put down margin in the form of post-dated checks and/ or un-cashed checks. The market soared, then crashed, and the Kuwaiti Gov't intervened with a bailout. There is a lot more to the story.



In tonight's race we sailed shorthanded. Normally, there are four good friends sailing together, but one was in an operation for a minor outpatient procedure.

We went through four head sails changes, which normally is not a big deal, but with 20 minutes before the race it can create a lot of work, tiring out the crew. Additionally, with one less person's weight to sit and balance off the energy hitting the sails it was hard to tack well.

We did really well, on the upwind and downwind leg. The reason was we went to our smallest head sail until we felt we could control the boat if the wind rose (which we did not expect). The wind didn't rise.

My takeaway was that by having less sail (leverage) we could attack more aggressively, which we did. We did well around the buoys, rounding tighter (closer) than others who were overpowered (too much sail up). I left before the results, but was pleased for the race.

Perhaps other sailors can apply this to a market discussion better than I.



It is surprising to note that the Sage of Nebraska has not been tarred with the same brush as many of the other financial companies that they regularly buy things from at deeply marked up prices.

I also note that oil is at its first N day low in a month, and this has had interesting predictive correlates with other markets in the past.



Some observations from the field based on my recent experience:

1) An analyst's ranking has everything to do with seniority and how well he knows a business or company, nothing to do with how well his recommendations have been doing.

2) The story you have to tell is more important than anything else. If you have a great buy without a story, forget about it.

3) Many investors seem to be looking for a 'trigger' or 'catalyst' that will re-value a company.

A quantitative study of stocks with a 'catalyst' or 'trigger' maybe could be done by counting how many times these words appear in analysts' research for a particular stock, to see if these stocks over- or underperformed. Wouldn't be surprised if stocks where investors have high hopes for a trigger (such as new regulation, spin-off or announcement of buyback) will have underperformed. I personally like stocks without any kind of triggers.



At the through of the market dip in March , the Dax Index was more or less at 6,400 while the Bund reached 118 and some, flirting around the 4 % yield for some time. With the recovery of stock markets around the world , the Bund and the treasury markets retreated to lower prices as investors returned to invest in riskier assets. After the last three days of credit crunch fears and rumors of yet other American financial institutions in trouble, the inverted correlation in price movements of bonds and stocks seems to be fading. We must of course take into account the fact that inflationary expectations are greater now than in March; yet the fact that investors don't seem, for the moment, prone to rush for safety is rather bullish for stocks. (At least until the next financial catastrophe).

Vic adds:

Quantitatively speaking what you report is confirmed, on a weekly level.



BurjMy sister just called me with an update of the property market in Dubai, where she has been living for the past six years. Her property has increased in price by around 2.5x in just as many years. It's astonishing, especially when contrasted with what's happening here in the UK. However, she says that prices are now equivalent to London prices in the area where she lives. With general prices still rising rapidly in Dubai, I imagine the cost of living is no longer the great selling point it once was. Are we near the top? I've no idea, but I'm paying a visit to Dubai at the end of the year and it will interesting to compare with my last visit some five years ago.

Whilst too much inflation is thought by many to be a bad thing for stocks, bonds, and life in general, I keep wondering whether there are some tasty investment treats out there in countries with fixed exchanged rate regimes, especially as many are pegged to the USD, and are thus importing a relaxed monetary policy and weak exchange rate. If you invest in these countries, whether there is true growth or not, can you simply convert the inflationary pressure into profit by investing in real assets on the ground?



DarkTitle: "Dark Matter" Director: Chen Shi-Zheng

There is little disagreement that the level of teaching, as well as the infrastructure, equipment, opportunities to advance and excel, in Asian grad schools are below those of the US in head-to-head comparisons. But our figures of qualified graduates in the sciences, no secret, have been discouragingly in decline for several decades, only partially stemmed by regular infusions of ambitious foreign blood, chiefly from Asian rim countries and the former Soviet Union.

… U.S. engineering and technology degrees in 1986 peaked at 97,122;
fell 16% to 81,610 in 2006, (Source: Washington-based National Center for Education Statistics)

.Data provided by the Chinese government showed 575,000 undergrad engineering degrees awarded in 2006. That stat is inflated because China classifies 'engineer' to include auto technicians and other jobs not deemed engineers in the U.S. (Source: Vivek Wadhwa, adjunct professor, Duke University, in Durham, NC).

Actual number of Chinese engineers comparable in quality to those in the U.S. in 2006 may have been closer to 60,000, Wadhwa said in a May 28 telephone interview. He noted that is less than half the number of U.S. graduates in the same year, citing figures that include computer scientists not in the National Science Foundation survey.

(Courtesy, Alex Forshaw, research data)

Despite the alarming data, we can discount the Cassandras to some extent, in that the culture-wide discouraging of innovation, and the lack of current world publications, is also a significant barrier to advancement. Brain-power alone, though wonderful, does not alone make up for the infrastructural and cultural deficits cited.

A good film to see that deals with the influx of gifted Asian–especially Chinese-students to top universities, "Dark Matter" watches one case-history: A special-import to MIT, in the astrophysics department. The department head, reaping the laurels of a theory that is received wisdom, is externally about support and nurturance. As the protagonist, Liu Xing, shows, what protege relationships involve is being a yes-guy, not rocking the boat, and finding ever-more-emphatic ways of lavishing agreeableness on the mentor. Or else. Liu's troubles with the American system of exclusionary perks and treatment, college politics and the importance of 'blending in,' can be found as assertive subtext throughout the film.

"Dark" stars brilliant Chinese student Liu Xing, played by Liu Ye (Postmen in the Mountains, Balzac and the Little Chinese Seamstress, Purple Butterfly and Curse of the Golden Flower), unconsciously jockeying for top-rung among a thrush of foreign students in astrophysics and cosmology. His innocence as to the ways of academe result in his being chastised for original thought running counter to the published pet theories of his 'easy-going' but territorial mentor, Jacob Reiser, Aidan Quinn. (Note: "Jewish" professor. Depicted on the silver screen by a non-MOT. Typical.) Meryl Streep, a feather-headed wealthy Asian-student fetishist of sorts, is in the film for mere nanoseconds, trying to rectify what she sees as the institutional unfairness of favoritism, not merit, against the star Sino-import. Lui discovers an unprecedented innovation in the field, but is stonewalled at every turn by Professor Insecure. Liu is recognized as stellar (pun intended) in theory if not burdensome sociological comportment, but only Streep extends compassion to the blocked and chastised student. Not even Streep can hoist Liu over the fence of lethally competitive college politics. It's blindingly clear: No matter how innovative, Liu will never get his Ph.D.

A fascinating topic by itself, dark matter forms the building blocks of the universe, but far too little is made of the actual meat and potatoes of the science of cosmology. The film is both too general and too presumptuous, letting the observer flail about in ignorance. Unless he/she already knows the field, in which case, it is also unsatisfyingly vague and nonspecific.

If the subject matter is worthy of attention, an entire movie to itself, couldn't the writer/director, Chen Shi-Zheng, give us more to marvel at and gestate? Though based on a true incident in 1991 of a University of Iowa student losing his control to tragic effect, it seemed that a better film was lurking right outside of earshot. The subject matter remains important; academe remains a pungent venue for a suitably marinating speculum; and the topic of foreign students 'out-brillianting' home-growns remains a potent topic for discussion and study. This film isn't it.

The epic shortage of stateside scientists and engineers is not directly addressed, but hinted at throughout. As we are told, somewhat unreliably, this shortfall is being addressed in financial invigoration of science and engineering departments. But based on the current crops and results, we have a way to go before we regain lustrous supernova status.



Tennis shoesSince my high school tennis team wasn't very good, it wasn't supported from the school. I had no problem with that, as I still got first dibs on the courts right after school. We'd play a few sets until it got dark and the lights were turned on. This is when the guys in their 20s and 30s would come in and chase us off our home court. I'd sit and watch the games of the older guys, and would carefully analyze their games, strategies, and moves. I spent quite a bit of time watching a guy who would show up at our court, an NBA player who played for the 76ers, and later became a head coach until retiring last year. He would show up every night at the game with his buddies, and they put on a heck of a show. They were power hitters, who tried keep a fast, hard game going. Unfortunately, the volleys didn't last too long, most balls ending in the net. The NBA player was the best of the three, as he had a serve similar to Rod Laver's: very fast, straight, and deadly. He also had the worst backhand I ever saw, and took great pains to protect it. After I thought I had made his game, and Achilles heel dialed in, I waited until he was finished with his buddies, then offered to play him for a crisp picture of Franklin, two out of three sets. He was amazed that a 16 year old kid would offer to challenge him to a match, and for big money in 1972. He thought it would be like stealing candy from babies. When I stepped up to the baseline, I answered his serve with a nice, slow dink shot to the corner of the baseline of his weak backhand. He had little control over that shot, and I was able to put it away. Since his game was speed and power with nice forehand ground strokes, I answered with slowness, dink shots, lobs, and hitting crosscourt keeping him running. I maneuvered him into the corner numerous times, where his weak backhand could only get the ball right up to the net, where continuously I put the ball away. By the end of the first set, with me up 5-1, his emotions took over, and I then owned him for the match. Needless to say, I ended teaching him a lesson, that one can play one game well, but it is the rare person who can play all games well. He politely settled with me after the match and was impressed that a 16 year old kid with a Davis racket could soundly beat his power game. Actually, he beat himself bloody. In the markets, one can employ similar defenses, by playing at a different speed, using arcane strategies,deception, and confusing the opponents. I learned that scouting my opponent gave me a huge edge, despite the fact the NBA player was a better technical tennis player and athlete than I was. A weak market player can lie in wait for months until a slam-dunk edge opportunity presents itself. The weak market player who's right can then attack when the conditions least expect it, and bring down a larger player. Big players often are only capable of one game, the one they play well. It's the variants of the same game that kills them.

I wouldn't have been able to step into the court had I not spent many, many, years of practice, as practice is the most important part for learning and keeping any skill.

If there are parallels between tennis and the markets, then by default, there should be parallels between tennis and checkers, or chess. I'd be interested hearing readers' thoughts.



I am struggling with circadian desynchronization after returning from Korea. I went with my wife and two teenage children. One place we went was Jeju, a subtropical island south of the Korean mainland. Our flight from Seoul to Jeju (or Cheju)was nearly filled with high school students in uniform on end-of-year school trips. The students cheered and chanted during takeoff and landing. It felt more like being on a school bus than an airplane.

The next day, we saw hundreds of students everywhere we went on Jeju. On Jeju, the students did not wear their uniforms. Nearly all wore T-shirts with English messages on them, many of which were grammatically incorrect or nonsensical, entertaining my teenagers for hours. T-shirt slogans included "This is a REALLY many", "Tink before you walk" (with the emphasis on the word you), and "What's so 411 about hot sand music?"

Back on the mainland a few days later, we saw dozens of old men playing go in a park in Busan. In the countryside, we saw much highway construction.

We rode a bus with a tour group of Korean-Americans. Traditionally, parents of grown children live in their eldest son's household. One man in our tour group felt conflict because he had relocated for a job opportunity, in the process moving away–at age 33–from his widowed mother, who was on the tour with him. Another man in our group, a retired Wall Street banker, predicted a two-year recession for the United States because of excessive debt and said that Korea faced a similar gloomy prognosis.

We spent a few days in Seoul, a city of 13 million. I saw many cranes constructing new high-rise buildings. Late one night I was ready to turn in when I heard noise from outside. I looked out the window and saw hundreds of people parading in the street and blocking traffic. They were shouting and chanting too indistinctly for me to attempt to understand. At some point, they all began singing the national anthem. I later learned that this event was a political protest against allowing beef imports from the U.S. Our tour guide said that the reason many Koreans opposed beef imports was that the U.S. would dump low-quality or unsafe beef in Korea. I had trouble believing that any U.S. exporters using such a strategy would stay in business long in Korea, but I did my best to be a polite guest.

The Korean language is quite interesting. The verb usually occurs last in a Korean sentence. Prepositions and auxiliary verbs are often expressed by appending endings to words. The word order in a complex Korean sentence often seems to me to be nearly the reverse of the English word order. To express "I do not speak well" in Korean, one would use the word order "I well cannot speak". It occurs to me that the study of how communication occurs in different languages might yield some insights for those of us trying to understand the message of the market.



My father handed over the wealth of his knowledge from a lifetime of speculating the night before I was leaving home and starting a career in the markets of Mumbai:

1) Sleep well and enough and at regular hours. Deprived sleep doesn't get compensated by catching up.

2) Eat well and at regular hours. An upset stomach makes the mind waver. Drink lots of water.

3) Speak only when necessary. Never loudly.

4) Listen.

5) Gather facts, steer clear of opinions.

6) Stay away from losses. Money will come from chance.

7) Don't trust anyone completely. But trust.

8) Write your books of accounts everyday.

9) Adjust sleep if any of these don't work well.

Dad wrote this list to me many times in several of his letters again and again across years. I am still trying to improve. He tells me his father gave him this list.


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